Cost and Management Accounting

Session 1

Chapter No 1 Management Accounting Fundamentals

 Concept of Management and Cost accounting – An
Introduction

All businesses are concerned about revenues and costs

 Managers at companies, small and large must understand how
revenues and costs behave or risk losing control of the performance
of their firms
 Managers use cost accounting information to make decisions
about research and development, budgeting, production planning,
pricing and the products or services to offer customers.
Sometimes these decisions involve trade-offs.
 Management accounting assists Managers in taking such
decisions to optimize the revenues and minimize the costs

2
 Concept of Management and Cost accounting – An
Introduction
Financial accounting: Financial Accounting focuses on reporting
financial information to external parties such as: investors,
government agencies, banks and suppliers based on
Generally Accepted Accounting Principles(GAAP).
Cost accounting: This is the process of measuring, analysing and
reporting financial and non-financial information related to the costs
of acquiring or using resources in an organization.
Management accounting : Management Accounting is the process
of measuring, analysing and reporting financial and non-financial
information that helps managers make decisions to fulfil the goals of an
organization.
Managers use management accounting information to:
 Develop, communicate and implement strategies
 Coordinate product design, production and decisions
marketing
evaluate a company’s and
performance
3
 Financial accounting Vs Management accounting… 1/2

Basis Financial Accounting Management Accounting

Objectives It helps in finding out the It helps in computing cost
results of an accounting year of production/ service in a
in the systematic manner to
form of P&L account and control cost
prepares the Balance
sheet
Reporting It is concerned with reporting It is an internal reporting
the results and position of system for an
business to persons and organisation's own
authorities such as management for decision
Government, Creditors, making
Investors and Others
Data Analysis Data is historical in nature Data is not only historical
but also futuristic in
approach
Cost Major emphasis is on cost Classification is on the basis
Classification classification based on type of Functions, activities,
of transactions - Salaries, products, Process and on
repairs, Insurance, stores etc internal planning and
4 information
control and
needs of the organisation
 Financial accounting Vs Management accounting… 2/2

Basis Financial Accounting Management Accounting

Accounting Only those transactions are It uses both monetary as
transactions recorded that can be well as quantitative
expressed in monetary information
terms
Effective It aims at presenting " true It aims at computing " true
purpose and fair" view of the profit and fair" view of the cost of
and loss position and financial production/ services offered
position of the organisation by the firm
Statutory Financial accounts are subject Management accounts
requirements to statutory audit to verify are subject to cost audit
whether they disclose " true that verifies whether the
and fair" view of the profit cost accounts disclose "
and loss position as well as true and fair" view of the
financial position of the cost of production of the
organisation company

5
 Cost accounting Vs Management accounting
Basis Cost TermAccounting Management Accounting
Concerning issue It is mainly concerned with It evaluates the impact
allocation, distribution and and effect of costs on
accounting aspects of operational decisions
costing
Data The costing data is the basis It uses both the Financial
of management accounting accounting and cost
decisions accounting data
Scope It has a narrow scope It has a broader scope in
in Business operations analyzing managerial
decisions
Term It is for short term planning It is concerned with both,
short term and long term
planning
Functions It assists only in It also helps in
Management functions performance evaluation
of managers and workers
Approach It is a historical approach It is a futuristic approach
Interdependence It can be installed without It cannot be implemented
the Management without the Cost
accounting system 6 system
accounting
 Financial Accounting Functions on Well-Defined Concepts
and Conventions

 The concept of “separate entity” implies that the owner (person) is

different from business.
 The concept of “double entry system” explains that each and
every transaction has two-fold effects. It simply means that in a
transaction, two accounts are affected.
 Another concept called “money measurement concept” means that
only those transactions that can be expressed in monetary terms will
be recorded in the books of accounts.
 According to International Accounting Standards, an enterprise is
normally viewed as “going concern” if it continues to remain in
business for the foreseeable future.
 The “matching concept” has been defined by International
Accounting Standards as, “an accounting practice whereby expenses
are recognized in the income statement on the basis of a direct
association between the costs incurred and the earnings of specific
items of income 7
 Cost Accounting

Cost accounting is a technique to optimize cost of production/services

by using different costing techniques and reaching a competitive
stage in a given business scenario.
1. Cost can be described as the resources that have been sacrificed or
must be sacrificed to achieve a goal. This is a sort of investment
made to produce a product or service. As long as this product
remains in the firm, it is treated as an investment or asset.
2. Costing is the systematic procedure of ascertaining the cost of a
product or service. Costing broadly deals with the cost of
production, selling and distribution.
3. Cost accounting is a system of accounts for determining the
cost of products or services. It deals with preparing budgets;
monitoring standard costs and actual costs; and costing of
processes, activities or products. It also analyzes cost accounting
information and data for various managerial decisions
9
 Cost Accounting - Functions

The essential functions of cost accounting are as follows:

1. Ascertaining the cost of production on per unit basis.
2. Determining selling price.
3. Controlling and reducing cost.
4. Arriving at division-wise, activity-wise and unit-wise detail of cost.
5. Finding out inefficiencies and other weaknesses in the processes,
making available relevant data for decision making and estimating
future costs.

10
 Steps to Deliver Cost Excellence

 Build consensus and commitment on scope and goals

 Select the right methodologies
 Determine how efficient and effective the organization is and set
targets for change
 Develop a plan to hit the targets
 Drive implementation of the changes
 Make the change sustainable

1
1
 Objectives of Management Accounting
There are four broad objectives that Management accounting
accomplishes in an organisation:
1. Planning: Preparing a Plan and ensuring its execution to achieve short
and long terms goals. This is basically done through Budget
preparations.
2. Allocation of resources: The resources in terms of raw materials,
workforce and other requirements to facilitate production and
services efficiently are allocated to various divisions/units duly
assessing their requirements
3. Direction and Motivation: Once the resources are allocated in a
required manner, there is a need to direct and motivate
people for optimum contribution. Since the efficiency is linked to
incentives, the managers at different levels are engaged in
providing required direction and motivate people to contribute in
optimum manner.
4. Monitoring and Control: Proper monitoring at different intervals is very
much essential to achieve goals and optimize 12
the cost. The
management reviews the targets in relation to the actual state and
 Practical applications of Financial, Cost and Management
Accounting
 Financial accounting: It presents the position of assets, liabilities,
income and expenditure of a firm for comparative periods. It
only reflects the information as available in Books of accounts. It
represents past financial data and provides consolidated information
only.
 Cost accounting: It helps in preparing product wise statement of
cost, revenue and profit or loss by allocating various costs
according to the existing policy of the firm. It also indicates which
product is making profit and which ones are in loss.
 Management accounting: It analyses different cost elements by
allocating them in a very scientific manner to arrive at correct
contribution from different products. Based on an in-depth
analysis of costs, revenue, capacity utilization and contribution,
it also decides whether to buy a particular product from the
market or produce on its own. It also suggests if various strategies
can make a product profitable and if not, whether it will be wise to
shut down a plant or product 13
 To Summarise

Financial Accounting is Reporting

Cost Accounting is Implementation

Management Accounting is Decision Making

14
 Management Accounting – Definition and Features
According to the Chartered Institute of Management
Accountants , the definition of Management Accounting is
prescribed as “ The process of identification, measurement,
accumulation, analysis, preparation, interpretation and
communication of information used by Management to plan,
evaluate and control within an entity and to assure an appropriate use
of and accountability of its resources. Management accounting also
comprises the preparation of financial reports for non-management
groups such as shareholders, creditors, Regulatory agencies and tax
authorities.
1. MA is a decision making process based on various financial and
accounting information and data analysis.
2. It ensures adequate resources for operational units
3. It involves perfect monitoring and control through
responsibility management
4. It primarily focuses on achieving future strategies
15 and goals of
the organisation
 Management
Accounting
Information
and Their Use

Cost Monitoring Facilitates

Measuremen and Decision
t Control Making

16
 Management Accounting Information & Use

1. Cost Measurement: It measures full cost including Direct and Indirect

cost
Direct Costs – Those costs that are identifiable or traceable and can
be directly apportioned to the products or services.
Indirect costs – These costs are not allocated directly to the product
or services.
The measurement of full costs serves different purposes and is used in
different decisions
2. Monitoring and Control: Another important use of
management accounting information is to monitor closely the cost
aspect of a product or process and implement important effective
control measures to optimize the cost while not compromising on
quality.
This is done through the process of budget and budgetary control.
The targeted allocation of cost and actual is compared
17 at different time
interval
 Management Accounting Information & Use

3.Facilitates Decision Making: It generates appropriate and

required information for future decision making relative to various
operations of a firm.
The decisions may involve :
• Make or Buy
• Further processing
• Shutting down operations
• Increasing production capacity
• Determining selling process
• And other related decisions

18
 Management Accounting Tools and their Significance

Component Uses
Strategy Creating value for the customer through Proper planning
Formulatio and implementation of the strategies. The ultimate
n target is to reduce costs and improve efficiency
Efficient The flow of goods, services and information enhances
Supply Chain the performance of the firm. Tools such as Standard
costing and Target costing are effective for cost control
and cost reduction and thus ensure enhanced customer
satisfaction
Decision Techniques such as Marginal costing help generate
Making Science information that is useful for taking managerial decisions
such as Make or buy, drop a product line, additional
Working shift, Capital expenditure decisions etc
Analysis of Several tools such as Budgets and budgetary control,
Performanc standard costing and marginal costing are used in
e measuring actual performance
Responsibilit Fixing responsibility by creating different centers
y Centers such as cost, profit, investment etc

19
 Decision Making Process

 Planning:- Planning represents different phases of the planning

process in a firm which are:
o Strategy
o Positioning
o Budgets
 Directing:- It is the process of directing the operations for effective
use of resources. The three stages of directing are:
o Costing
o Production
o Analysis
 Controlling:- The process of controlling can be defined as a
process
monitoring and ofcontrolling measures to the desired
achieve effectively. The tools of monitoring and goals
control are:
o Monitor through MIS/ reports etc
o Score card
20
 Planning

Phase Description
Strategy Selecting the best alternates in terms of
cost, quality, etc , to fix the optimum
selling price and achieve goals
Positioning Where to place the product in terms of
geographical coverage (existing-new,
domestic- international), how to organise
and utilise resources at best cost to bring
efficiency and cost-effectiveness
Budgets Preparing short-term and medium-term
budgets based on past data and
information and keeping in mind the
organisational goals

21
 Directing

Stage Description
Costing Use and develop the relevant costing
technique to identify and allocate correct
costing to a product
Production Providing necessary resources
keeping in view the cost of resources.
Managers provide necessary
directions to optimise cost and bring
in efficiency.
Analysis Analysing actual versus budgeted
to ascertain gaps and to take
corrective actions

22
 Controlling

Tools Description
Monitor Regular monitoring at intervals to
ensure desired goals are achieved
Scorecard Strategic Management Accounting has
developed the concept of Balanced
Scorecard to effectively monitoring and
control

23
 Some Innovative Management Accounting practices

The management accounting policies and practices have changed

significantly depending on how accounting and trade policies and
practices have evolved across the globe.
Some of the new innovations in the field of management accounting
are:
1. Total Quality Management (TQM):-
 Focuses on maintaining the quality of a product or service
 It has significant impact on cost savings and bringing efficiency
in a product or service
2. Just- in-Time:-
 It is an approach developed in modern management
accounting to control the inventory holding cost by minimising
the level of inventory in hand
24
 Video Links

 Just in Time by Toyota: The Smartest Production System in The

World – YouTube

 Total Quality Management (TQM) - YouTube

25
 Some Innovative Management Accounting practices
contd…
3.Value Chain:- Many business firms define their mission to become one
of the prime brand in product or services line in which they
operate. In this approach the following analyses have been
undertaken:
a. Internal Cost Analysis
This is to asses different sources of profitability and the related cost
aspects for the purpose of creating internal value in various processes.
b. Internal Differentiation Analysis
This is to further investigate and understand the sources of
differentiation (including the cost) within internal value creating
processes.
c. Vertical Linkage Analysis
This is to identify the relationships and relevant costs among
external suppliers and customers so as to maximise the value
26
delivered to customers and to optimise the cost
 Value Chain Analysis Contd…
Value Chain Analysis Explained: The value chain is the sequence of
business functions by which a product is made progressively more useful
to customers. Let us illustrate these functions with Sony Corporations’
Television division :
1.Research and Development ( R&D): Generating and experimenting with
ideas related to new products, services or processes. At Sony, this
function includes research on alternative Television signal transmission
and on the picture quality of different shapes and thickness of television
screens.
2.Design of products and Services: Detailed planning, engineering and
testing of products and processes. Designing in Sony includes deciding
on the number of component parts in a television set and determining the
effect alternative product designs will have on the set’s quality and
manufacturing costs
3.Production: Procuring, transporting and storing (“inbound
logistics”) and coordinating and assembling (“operations”) resources to
produce a product or deliver a service. The production
27 of a Sony
television set includes the procurement and the assembly of the
 Some Innovative Management Accounting practices
contd…

4.Marketing ( including Sales): Promoting and Selling products or

services to customers or prospective customers. Sony markets its
televisions at Trade shows, via advertisements in newspapers and
magazines, on the internet and through its salesforce
5.Distribution: Processing orders and shipping products or
services to customers (“outbound logistics”). Distribution for Sony
includes shipping to retail outlets, catalogue vendors, direct sales
via the internet and other channels through which customers
purchase new televisions
6.Customer Service: Providing after sales service to customers. Sony
provides customer service on its televisions In the form of customer-
help, telephone lines , support on the internet and warranty repair work

28
 Value Chain Analysis contd….

Different companies create value for customers in different ways:

1.Gucci: It creates value for its customers by creating a prestigious
brand. It does so by focusing on marketing, distribution and customer
service to build its brand
2. Toyota: Focuses on Quality to create value for its customers
3.Ebay: Fast response times create quality of the online auction
giant’s customers
4.Nestle: It continuously innovates to make new products which are
healthier and tastier thereby striving to improve the quality of health of
their customer

29
 Management Accounting As a Profession

 Finance
 Marketing
 Human Resources
 Strategy and
Operations

30
 QUIZ TIME

Q1 . Which of the following are tools of management

Accounting?
a. Decision Making
b. Standard Costing
c. Budgetary Control
d. All of the Above

31
 QUIZ TIME

Q2 . Planning, Resource allocation, Direction, Motivation and

Monitoring
and Control are the four broad objectives of:
a. Cost Accounting
b. Management Accounting
c. Financial Accounting
d. Costing system

32
 QUIZ TIME

Q3. Cost accounting emerged on

account of :
a. Competitive markets
b. Statutory requirement
c. Wage rate Solution
d. Limitations of financial accounting

33
 Cost and Management Accounting
Session 2

Chapter No 2 Materials Cost Control

 Essential Features of Material Control Process

1.Coordination amongst departments: There has to be a

perfect coordination and cooperation among the other major
departments, such as production, procurement, warehouse, etc.
2. Organized: The material control process should be well
organized
with inbuilt supervision systems. It should be managed by
a
professional.
3.Standard schedules and formats: For an effective materials
control process, there has to be proper schedules and
formats of indent, placing orders and for maintaining other
inventory records. There has to be a dual control system to
maintain all records both in the soft form, as well as in the
physical form.
4.Verification and Monitoring: An internal mechanism for
verification and monitoring needs to be developed for bringing
more efficiency. 34
Essential Features of Material Control Process contd….

5.Modern and new techniques should be adopted, like bin cards, to

have timely monitoring and control over the inventory management.
6.Inventory level management: The minimum inventory level and
reorder level must be maintained.
7.Controls: The inventory recording system should be online with an
inbuilt control mechanism.
8.MIS: The firm should develop a sound management information
system (MIS) for better reporting, evaluation and control on
various aspects of inventory control.

35
Essential Features of Material Control Process contd….

9.Cost efficiencies: The perfect inventory management system in a

firm can help to save the maximum cost if a well-organized system and
mechanism are established. This will reduce the cost at different levels.
10.Material Purchase policy: The material purchase policy should be
more planned and systematic. There should be well-managed logistic
systems to ensure that the material is received well in time and at
the most effective cost.

36
Functions of Material Control Department

37
 Functions of Material Control Department

For having an effective control over the materials-related issues,

a firm usually has a well-established material control department. The
following are the it’s major functions:
1.Procurement of raw materials, keeping in the view time to
procure the materials, reasonableness of prices, quality of materials
used, and quantity of the materials
2.The raw materials are received and inspected to ensure the
required quality as per pre-specifications.
3.Storage of raw materials and maintaining the records of material
received in the store register. It also makes all the required
arrangements to prevent loss of materials due to leakage, pilferage,
theft, mis-handling, etc

38
 Functions of Material Control Department…

4.The raw materials are issued for the use of production on

receiving indent from the production department
5.Thedepartment also ensures adequate inventory control
through maintaining the proper records.
6.It is also responsible for timely supply of
the required materials and ensuring that the production
process does not stop for want of materials.
7.The overall responsibility of material’s price, quantity, inventory
control and recording lies with the production department.

39
Responsibilities of the Purchase Department

40
 Responsibilities of Purchase Department

1. Developing a mechanism for timely receipt of materials requirement

indents from all the departments to facilitate timely supply. The
department may prepare detailed guidelines and appropriate indent
formats.
2. Once the indents for materials requirement are received, there should be
proper mechanism of recording and follow-up of the indents with
predetermined time limits for control at different stages. This can be
maintained by allocating appropriate codes and description for different
items.
3. Empaneling the suppliers for requirements of different types of
materials. This is done by inviting tenders and finalizing them
based on price, quality, discounts, reputation, etc. This is done very
judiciously as the suppliers are not frequently changed.
4. All the records of price, terms and conditions, discounts, etc., are
recorded in the book for individual suppliers. The agreements and
contracts are also properly filed 41
 Responsibilities of Purchase Department contd….

5.Preparing purchase-order formats, which is contractual agreement,

should be prepared incorporating all terms and conditions as per the
agreement.
6.The orders for the purchase of relevant materials should be placed
in time to ensure that the materials are received on time. Once the
orders are placed, they should be followed at different levels.
7.Receiving materials at the store physically and storing them
after due inspection at appropriate places.
8.Returning back the defected pieces, if any, to the supplier and
follow-up for replacement or reducing the bill amount.
9.Verifying the invoices and sending them to accounts
department for payment to suppliers.

42
 Material Control Techniques

 Material inspection
report
 Goods received advice
 Materials transfer note
 Materials return note

43
 Material Pricing Methods

 First in First Out Method (FIFO)

 Last in First Out Method (LIFO)
 Highest in First Out Method
(HIFO)
 Average Cost Method
 Weighted Average Cost Method
 Periodic Average Cost Method
 Standard Cost Method
 Market Price

44
 Material Pricing Methods

1.FIFO:- Under this method of pricing, the materials received in

the store first are issued first and accordingly the pricing is done. In,
other words, the materials received in the first batch, are first issued
and only after all the items are issued from the first batch, the second
batch is used.
2.LIFO:- Under this method of pricing, the materials received last are
issued first. Therefore, materials issued carry the latest cost of material
acquisition.
3.HIFO:- Under this method of costing, the materials having the
highest price are issued first. Over here, it is not important when
the materials were purchased. The concept behind this approach
is that, in increasing and inflationary market, the cost of the material
is immediately absorbed into the product cost to cover the risk of
inflation. Since the material is issued at the highest prices, the product
costs also increases. However, this may affect the product to gain
competitive prices in the market. 45
 Material Pricing Methods

4.Average cost method : Materials are issued at the average process

of the material purchased
5.Weighted average cost method: Here, both, the price as well
as the quantities of materials purchased are considered.
6.Periodic average cost method: The average cost is calculated on the
basis of the materials received in a particular time period rather than
calculating the simple or weighted average cost every time the
material is received. The average may be calculated for the entire
period.
7.Standard Cost method: Under this method, the materials are priced
at a pre-specified standard price determined for the issue of the
materials.
8.Market price method: Materials are priced at the cost currently
existing in the market place as of the date of issue of the materials
16
 Material Pricing Methods

There is no standard rule as to which of the methods should be

used for pricing of materials
A firm may use any pricing method suitable to it. However, some of
the considerations may be:
• Method of production process
• Nature of materials used by a firm
• Frequency of purchases
• Economic Order Quantity
• Accounting practices acceptable in valuation of inventory etc

47
Economic Order Quantity (EOQ)

48
 Economic Order Quantity

This is a technique to determine how much should be the quantity

to hold which is economic in terms of cost. This helps the purchase
department to assess the quantity to be purchased at any one time.
This in essence is a measurement of how much quantity is to be
ordered at any one point of time.

Where: A is annual demand/annual consumption in

units O is the ordering cost
C is the inventor carrying cost per unit per annum
49
Number of orders to be placed ( Based on EOQ) = Annual Usage / EOQ
Minimum level = Ordering Level - (Average material consumption rate *
Reorder period)
Reorder level = (Maximum usage of material for specific period *
Maximum Reorder period)
Maximum level = Reorder Level + Reorder Quantity –
(Minimum consumption * Minimum reorder period
Average Level of material holding = (Maximum level of material +
Minimum level of material) / 2
Cost of Materials = Purchase cost + Total Ordering cost + Total carrying
cost

50
 Solved Problems

Q1.A materials Manager has the following data for procuring a

particular items:
Consumption of materials per annum =
10,000 kg Ordering Cost per order = Rs 50
Cost of raw material = Rs. 2 per kg
Storage cost = 8% on average inventory
holding
a. Calculate Economic Order Quantity

51
Consumption of materials per annum =
10,000 kg
Ordering Cost per order = Rs 50
Cost of raw material = Rs. 2 per
kg

Storage cost = 8% on average inventory

holding Carrying cost = 8% of Rs. 2 = 0.16

, i.e 4 orders per

annum

52
 Numerical

The John Equipment Company estimates its carrying cost at

15% and its ordering cost at $9 per order. The estimated annual
requirement is 48,000 units at a price of $4 per unit.
Required:
• What is the most economical number of units to order?
• How many orders should be placed in a year?
• How often should an order be placed?

23 53
 Solution

1. What is the most economical number of units to

order?
• Annual requirement = 48,000 units
• Ordering cost = $9 per order
• Carrying cost = 15% of per-unit cost
• Per unit cost = $4 per unit

23 54
2. How many orders should be placed in a year?
= Annual requirement / EOQ
= 48,000 units / 1,200 units
= 40 orders
3. How often should an order be placed?
Frequency of orders = No. of days in one year / No. of
orders
= 360 days / 40 orders
= 9 days

55 2
5
 Material Management at Stores

The following functions are undertaken by the storekeeper as regard

to efficient management of materials:
1.Maintaining a buffer in case of emergency and ensuring timely
availability of materials.
2. Providing safety and security of the materials.
3.Maintaining just sufficient quantity to avoid over/under
stocking of the materials.
4.Designing and developing a proper system for ensuring control
over usage, with proper recording system of issues and receipts of
material inputs.
5.Minimizing material losses on account of mishandling,
wastage, evaporation, breakage, etc.
6.Proper up-keeping of records and documentation for recording the
receipts and issues.
56 2
5
 Inventory Control Techniques

 Perpetual Inventory System

 ABC System of Inventory
Control
 Just-in-Time Inventory Approach
 VED Analysis of Inventory
Control
 FSND Analysis

57 2
5
 Inventory Control Techniques
1. Perpetual Inventory System:- The continuous stock taking system is
known as the Perpetual Inventory System. According to the definition
of CIMA, The Perpetual Inventory System is “the recording, as they
occur, of receipts, issues and the resulting balances of an individual
items of stock in either quantity or quantity and value”.
2. A B C System of Inventory Control:- The items of inventory are
categorized according to the value of usage of material inputs. The
materials are classified into three categories as A, B and C according
to their values. Items under category A constitute the most important
class of inventories in the overall proportion in the total value of
inventory. The A items constitute between 5- 10% of the total items
but value maybe almost 80% of the total value of inventory.
Category B items constitute an intermediate position, i.e. 20-25% of
total items and 15% of total value.
The philosophy behind this system is that the items having highest value
should be controlled more carefully as they involve higher cost of holding.
On the other hand, items having medium and small values in terms of
costs, despite large in quantity can be controlled periodically
What is ABC Inventory Analysis? - 28
YouTube
 Inventory Control Techniques contd….
3.Just-In-Time Inventory Approach:- Just in time inventory (JIT) approach
of inventory management was developed by Japanese firms with the
concept of no inventory holding and therefore avoiding completely the
inventory holding costs. This is the more recent trend in inventory
management. This principle focuses on total elimination of the
intermediate stages like score-keeping, maintenance, etc. The materials
ordered and purchased from supplier should directly reach the assembly
line exactly when they are required for the production process. There is
no need of storing the materials and then carrying them to the assembly
unit.
What is Just-in-Time (JIT) Inventory Management? - YouTube
4.V E D analysis of Inventory control:- The analysis known as vital, essential
and desirable (VED) is based on the degree of criticality of the raw
materials in a firm. According to this approach the materials are divided
into three categories in the descending order depending on their criticality.
‘V’: is an indication of vital items and their stock analysis requires prime
focus. ‘E’: signifies the essential items required by a firm in the
59
production process. ‘D’ : relates to desirable items
 Inventory Control Techniques contd….

5. FSND analysis:-The holding period of materials which is known as age

of the inventory is also an important element based on which the
materials can be controlled. This analysis categories the material based
on their movement
F : Category F denotes fast moving items and those stocks which are
consumed in a short span of time
N: These are normal moving items of the stock and are generally
utilized over relatively longer period from 6 months to 1 year.
S : Is an indication of slow moving items. The stock holding period in
such cases is more than 1 year. The holding is reviewed periodically and
in case they are not required , they can be eliminated
D : D is dead stock. This means that there will not be any further
demand for such items. Therefore, the firm identifies such items and
eliminates from the stores or makes alternate arrangements
60
 Lets test our understanding !

1. In ABC analysis, high cost items are most likely to fall in Category A
and least cost items are likely to fall in Category C. State
whether True or False.

2. EOQ is based on a balance between Inventory carrying costs and

shortage costs. State if this statement is right, Why ?

61
Material Control : To exercise effective control on Material movement
Material Requisition slip : A slip devised for giving orders by the
departments to issue materials
BIN card : Maintaining quantitative record of materials
FIFO: Material priced on the basis of receipts in the stores first to be
issued
LIFO: The materials received in the last are issued first and
priced accordingly
ABC: Categorization of materials inputs based on their importance
J I T : An inventory management system where inventory are received
directly in the assembly just in time.
Bill of Materials : A schedule of details of materials received and
issued E O Q : Optimum level of quantity to be ordered at a time
V E D : Categorization of material inputs as vital, essential and
desirable
62
 Summary

Raw Material Costs and management process :

Raw material inputs are the most significant in a manufacturing unit as
they form approximately 60% of the total cost of production
It is very important to have an adequate control on the cost of
material acquisition
Efficient Materials issue process is a fundamental requirement to
ensure timely availability of materials by the concerned departments
Appropriate pricing policy for issuance of materials from Stores to
Production department

63
 Summary
Bin card:
a. It is the quantitative record of all receipt of the materials,
issue of materials and the balance of materials on a particular day
b. This record is kept for each and every material and entries are made
daily after every receipt and issue
c.It contains quantity and other
details Inventory Control:
d. It is one of the most important aspects in effective material
management of inventory and its control
e. Both Under-stocking and over-stocking are undesirable. Hence
assessment of Maximum level, minimum level and reorder level
is imperative for efficient cost management
f. Inefficient management will result in higher cost and losses to the
firm
64
Cost and Management Accounting
Session 3

Chapter No 3 Labour Cost and

Overhead cost Control Analysis
 1. Labour Cost

All businesses are concerned about revenues and costs

Managers at companies, small and large must understand
how revenues and costs behave or risk losing control of the
performance of their firms
Managers use cost accounting information to make decisions
about research and development, budgeting, production
planning, pricing and the products or services to offer
customers. Sometimes these decisions involve trade-offs.
Management accounting assists Managers in taking such
decisions to optimize the revenues and minimize the cost

66
 Labour Cost Control – An Introduction

3 major componentsinvolved in the manufacturing process of

a product are:
 Materials
 Labour
 Overheads
The control of labour cost is a sensitive issue as it involves
human factor and even slight mishandling may create a
problem for the organisation

67
Issues Concerned with Labour Cost Control

1. Classification of Labour Cost

2. Labour Cost Controls
3. Process and Production
Planning
4. Labour Budget
5. Standard Labour Cost
6. Job Performance Report
7. Work Performance Incentives

68
 1.1 Classification of Labour Cost

1.Direct Labour Cost: It is the amount of Remuneration that can be

identified and attributed directly to a product or service unit.
2.Indirect Labour Cost: Remuneration payable to the workforce where
their skills and contributions are not directly related to the particular
product or service unit. Eg: Salaries and wages paid to supervisors,
security staff , stores staff etc
Eg : Consider labour costs for programming at companies such as
Apple where programmers work on different software applications for
products like the iMac, the iPad and the iPhone.
• Direct programming costs that can be traced to individual products
•Indirect Labour compensation for : Office Staff Office Security
Salaries for Department Heads, supervisors and Managers Payroll Fringe
costs eg: Health care insurance, pension costs etc

69
 1.2 Labour Cost Controls

Various methods of controlling labour costs are :

 Hiring workers as per Budget allocated by the company to Labour
cost •
 Proper time recording systems
 Allocating standard labour cost for the job or the product
 Proper maintenance of job profile of individual employees

70
 1.3 Process and Production Planning

 This can be achieved by proper planning of the production

process in a scientific manner.
 The production planning process may involve activities like
planning, scheduling, routing, machine loading, product
and process engineering, work study through well laid down
norms.
 Time and Motion study is a significant mechanism which
helps in fixation of standard time for a particular job
 Once the standards are fixed, the monitoring process becomes
simple as you have to analyse the actual costs with the
pre-determined standard

71
 1.4 Labour Budget

A firm prepares various budgets to have effective control on

various operations
The labour budget is prepared to forecast the budgeted
expenditure on workforce activities like recruitments, wages and
salaries and other remunerations.
It helps in Budgetary control.
At the end of a particular time period, an analysis can be made to
assess the variances between budgeted levels and actual costs
under different component

72
 1.5 Standard Labour Cost

 An organisation may determine the labour costs on a per unit

basis to compare with the actual labour cost.
 The standard labour cost is the cost which is determined based
on the past trends, industry practices, technological aspects etc
 This is determined under optimum working conditions and
helps a firm to adhere to adequate controls in the future
 The standards can also be fixed based on time and motion study
 This has been an effective way to monitor and control the labour
costs

73
 1.6 Job Performance Report

 A firm may introduce individual job performance report which

can be used for performance evaluation periodically.
 This will indicate labour efficiency and time utilization by
the individual workers
 This is an important tool in measuring the efficiency and
productivity of workers

74
 1.7 Work Performance Incentives

 Incentives related to work performance have a significant impact

on the productivity of workers
 There are 2 aspects to it: Costs and Increased Productivity
 An organisation has to decide the balance between
incentives and productivity i.e determine the amount of
incentives that will bring efficiency in the production process vis
a vis the additional cost of such incentives
 Improving labour productivity has a direct impact on labour
cost per unit
 Incentives may be Monetary or Non-Monetary
 Incentive schemes should be reviewed from time to time to
understand their efficacy and impact on productivity

75
Labour Attrition rate or Labour turnover is the frequency of
2. Labour
Labour Attrition/
exit from Turnover
one Organisation to another in a given period of
time

76
 Factors Affecting Labour Turnover

Internal Factors for Labour Turnover

1. Labour may not be satisfied with the type and process of job.
2. There may be problem with the scheduled working hours which
may not be suitable.
3. The working environment prevailing in the factory may not be
conducive.
4. Lack of cooperation among the workers.
5. Unhealthy relations with the superiors and management.
6. The remuneration policies may not be suitable as compared to other
firms. There may be lack of incentives and motivations.
7. This apart, there may be other causes like inadequate facilities in
terms of health insurance, inadequate safety measures, high risk
in operations, lack of suitable promotion policy, inadequate
arrangements for training and absence of other77incentives
 Factors Affecting Labour Turnover

1. Turnover due to retirement, death and other family and personal

reasons.
2. Continuous ill health, accident and other physical problems.
3. Location change of a worker.
4. Other social and family circumstances.

78
 Labour Turnover & Its Costs

Co-relation
Higher the labour turnover, higher will be the cost of the product to a
firm. Hence, Firms set strategies to minimise the labour turnover. The
costs related to labour turnover are:
Preventive Costs
 Prevention is better than cure
 Costs of personnel management
 Costs of providing better medical facilities
 Costs for providing transport, housing, other facilities
 Costs related to pension, gratuity schemes and post-retirement
benefits
Replacement Costs
 Cost of recruitment & training a new worker
 Loss of output due to lower efficiency of new worker
 Loss on account of increase in wastage
 Costs of machine breakdown
17
Measurement of Labour Turnover

80
Measurement of Labour Turnover

81
 Solved Example on Labour Turnover

The following information is available from the records of

personnel department of XYZ & Co. for the month of January
2023. Total workers in the beginning of the month were 1900,
whereas at the end of the month were 2100. During the
month, 25 workers left the firm on account of their own
problems while 40 workers were discharged. 280 workers were
engaged during the month in various departments. But out of
them, only 30 were appointed. Compute the labour turnover
using different methods of labour turnover measurement.

82
Summary

83
The average number of workers has been computed by considering
the (opening number of workers + closing number of workers)/2
= (1900 + 2100)/2 = 2000

84
 3. Time Recording

Following is the significance of maintaining proper record of time for

each of the worker:
1.Measurement of Productivity: The total number of hours worked by
each workman can be ascertained for the purpose of calculations of
wages, salaries, incentives, etc. This is more relevant in the firms
where workers are paid wages as per the time rate plan.
2.Punctualityand Discipline: This is also required to keep a
track on punctuality and discipline among the workers. Each
worker remains conscious about the punctuality and timings.
3.Calculation of Benefits: There are certain mandatory
requirements to receive benefits like pension, gratuity, leave with
pay, provident fund, promotion and salary scale on the basis of
continuity of service. In that case, attendance records are required to
properly verify to ascertain eligibility for such benefits.

85
 4.Calculation of Overheads: In cases where the firm follows the
policy of overhead allocation based on labour hours, a proper record
of time keeping is very much required to measure the exact number
of hours consumed for the product.
5.Labour Efficiency Ratio: There is also significance of maintaining
time records for workers to ascertain the standard time for work
and thus calculate the idle time spent by workers. We can also
calculate the labour efficiency ratio by maintaining proper time
records.

86
 4. Method Study

1. This method is more appropriate where jobs are complex and

operations are costly.
2. It is necessary to have all the related information about a job, like
purpose, location, sequence, relationship with other works,
methods of working, operators, requirement of skilled workers,
facilities required, etc.
3. The working systems are modified and redesigned after
studying the relevant aspects of the job in details. This may help a
firm to change the location and sequence of the work, methods of
production and the layout for the job, depending on the study
results. This will bring more efficiency, effective way of completing a
job and quality improvements.
4. There is a need for close monitoring and follow-up to evaluate the
modified systems. Thus, method study is more significant for
utilizing resources more efficiently and to achieve higher level of
87
production with reduced costs.
 5. Job Evaluation

1. Job Ranking Method

• Under this method, jobs are ranked according to the importance
on the basis of skills required, education, experience
requirements, working conditions, etc.
• A ranking is done by comparing the other jobs.
• The different jobs are rearranged in the similar order. The wages,
salaries and other compensations are decided on the basis of ranks.
• This method is simple and can be used when the size of the
organization is small

88
 Evaluation of Job

2. Point ranking method:

• The jobs under this method are analysed in terms of job factors
or characteristics.
• The job factors may include skills required, efforts involved,
working conditions, etc.
• Thereafter, each job factor is given weight or points based on its
value to the job.
• The jobs are ranked according to the total score and placed
under pre- decided grades.

89
 Evaluation of Job

3.Grade description method: as a matter of policy, a firm

decides, in advance, certain grades according to education,
experience, skills, etc. and the jobs are placed in a suitable grade.

4.Factor comparison method: In this case, a firm identifies some key

jobs and ranks them according to different factors. The jobs are
ranked and evaluated skills, responsibilities, working conditions,
etc. The jobs are evaluated and compared with other jobs and a
factor scale is constructed

90
 Evaluation of Job

5. Merit Rating:
 Job Evaluation is concerned with the rating of a job to establish
rationality to design wages and salary structure in an organisation.
 Merit Rating is the process of comparative where analysis of
merits of individual workers assumes significance.
 Thus Merit rating aims at evaluation and ranking of Individual
workers
 This helps in designing and implementing rational promotional
policies

91
 Evaluation of Job

Objectives of Merit Rating:

1. To evaluate merit of workers for promotions, increments,
rewards and other incentives.
2. To establish and develop a wage system and incentive scheme.
3. To identify and allocate appropriate and suitable jobs for the
workers.
4. To develop a self-designed system enabling a worker to
evaluate own merits and identifying areas needing
improvements and developing capabilities and competencies

92
 Evaluation of Job

6. Time and Motion Study:

Two studies (Time and Motion) need to be performed Motion study
precedes Time study
In Motion Study, a job is divided into fundamental elements or
basic operations. It is a study of all movements in a job, process or
operation to find out the most scientific and systematic approach of
performing a job.
Time Study measures the time required to be spent on a job
as per predetermined standards (derived from Motion Study). The
work to be performed is observed under specified conditions by
direct observation using a time measurement device to rate individual
elements.
The standard time is fixed after considering normal idle time.
Time and Motion Studies help in designing efficient incentive systems
93
 Evaluation of Job

Objectives of Time and Motion Study:

1. Bringing more efficiency in the production process by removing
undesired motions in the process.
2. Designing and developing improved methods, techniques and
processes for completing the job.
3. Effective and efficient utilization of resources.
4. Developing a conducive work environment through proper layout of
plant.
Advantages of Motion Study:
1. Proper assessment of labour requirement
2. Promoting incentive systems by fixing suitable standard time.
3. More realistic labour budget and production budget
4. Bringing about improvements in labour productivity by designing
more scientific methods for job performance.

94
 6. Wages & Incentives

1. Flat time rate system:

Under this method, the workers are paid on an hourly, daily or weekly
basis based on the time spent on the job. The overtime is paid
as per the requirements of the act. The workers under this
system receive a fixed minimum income irrespective of the output
produced by them. This method is useful in a job where in the quality
is a concern, where an individual worker has hardly any control over
the job and the speed of production is governed by time.
Wages= Number of hours worked x wage rate per hour
The benefit of this method to a worker is that the worker is
assured of minimum income irrespective of the output produced.
Therefore, the quality of product becomes a focus. The limitations to
this method are that it doesn’t offer any incentives to the efficient
workers

95
 Methods of Wage Payment

2.Time day at high day rate plan:

Under this system, the workers are paid at time rate but the rate is
much higher than that is normally paid in the industry.

The workers who are efficient, skilled and experienced are selected to
work. The wages are paid according to the time taken to complete a
job.
This method offers high incentives to the talented workers.
A very less degree of supervision is required under this method.
However, ensuring that a high day rate is really brought, the desired
results are difficult
Wages = number of hours worked x high day rate per hour

96
 Methods of Wage Payment

3. Graduated time rate plan:

Under this method, wages are paid at different time rates.
The wage rate varies according to the efficiency of the workers.
The normal wage rate is paid for standard efficiency and a higher
wage rate for increased efficiency.

97
 Methods of Wage Payment

4. Piece rate method:

 Under this method, the workers are paid according to the
production performed by them.
 A worker who produces greater output, earns higher wages. This
can be a straight piece rate system where rate per unit is fixed
and the worker is paid according to this rate.
 There can also be a differential piece rate system where standard
rate per hour of production is increased as the output level also
increases.
 The increase in rates maybe proportionate to the increase in
output or proportionately more or less than the pre-determined

36
 Methods of Wage Payment

5. Taylor’s differential piece rate system:

 This system presumes that there are only two classes of workers,
efficient and inefficient.
 The model suggests that while efficient workers must be encouraged
to the maximum level possible, inefficient workers should be
penalized.
 Therefore, two different rates have been suggested for the two
different classes of workers.
 According to this system, if the worker is efficient, he should be paid
120% of the normal piece rate while the inefficient workers they should
be paid at 80% of the normal piece rate.
 The standards of production are pre-fixed. If the production
exceeds the standards, it is considered efficient (and if not, it is
considered inefficient.)
99
 Methods of Wage Payment

6. Gantt task bonus plan:

This model was developed combining time rate, bonus and piece
rate plan. This model suggests the following remuneration system :
 Output: Below Payment :Guaranteed wage rate
standard
Payment: 20% bonus of time rate
 Output: Standard
Standard high rate for the whole
 Output: Above
standard output
The advantages of this plan are as follows:
The workers who are below average receive guaranteed time
wages.
It differentiates efficient and non-efficient workers due to extra
bonus for efficiency.
However, the limitation of this plan is that it segregates the workers
on the basis of their efficiency which is not a good policy for
developing better relationship among the workers.
10
0
 Methods of Wage Payment

7. Halsey premium plan: The wages plan under this model was
developed by
F.A. Halsey, an engineer in the U.S.A.
 Under this plan, a standard time is calculated for each unit or job
an 50% of time saved is allotted as bonus.
 If the actual time taken by the worker to perform a job is lesser
than the standard, the worker becomes entitled to a bonus.
 The bonus is paid equal to the wages of 50% of the time saved. A
worker remains assure of the time wages if longer time is taken than
the standard time.
 Total Earnings= H x R + [50% (S-H) x R]
Where ‘H’ is the number of hours worked, ‘R’ is the rate per hour and
‘S’ is the standard time

10
1
 Methods of Wage Payment
8. Halsey Weir-Plan:

Under this method, only 33.33% of the time saved instead of

50% as suggested in the previous model. Accordingly the formula for
this method is modified as follows:
Total Earnings= H x R + [33.1% (S-H) x R]
Where ‘H’ is the number of hours worked, ‘R’ is the rate per hour and
‘S’ is the standard time.
The advantages are as follows:
• It guarantees time wages to the workers
• Differentiates efficient and non-efficient workers and provides
incentives accordingly
• It reduces the Labour cost
• When production increases, fixed overhead per unit gets reduced
• Overall production cost is minimize
However, the major limitation of this method is that, the workers
work in hurry to save more time and thus acquire a higher bonus which
may result in poor quality of the product or service.
10
2
 Methods of Wage Payment

9. Rowan Plan:
This is the premium bonus plan where bonus hours are
calculated in proportion to the time taken, where the proportion of
time saved to the time allowed is calculated and they are paid for, at
time rate.
Total Earnings= (H x R) + ( − ) x (H x R)
Where ‘H’ is the number of hours worked, ‘R’ is the rate per hour and
‘S’ is the standard time
The advantages of this plan are as follows:
• The worker receives guaranteed time wages
• Since the bonus increases at decreasing rate and efficiency, it
ensures the quality of the work receives importance at each level.
• The wages saved in terms of time is shared between both worker
and
employer and thus it helps in reducing the labour cost per unit
• It also helps in reducing fixed overhead per unit due to
increased production.
The limitation of this plan is that workers do not receive
10 full advantage
of the time saved and a highly efficient worker is not
3 equally
 Solved Questions

A worker takes 6 hours to complete a job under a scheme of

payment by results. Standard time allowed for the job is 9 hours. His
wage rate is Rs 150 per hour. Material cost of the job is Rs 1600
and factory overheads are recovered at 140% of total direct wages.
Calculate factory cost of the job using
1. Rowan system of incentive payments
2. Halsey system of incentive payments

Solution:
Given:
Time allowed (hrs) TA 9
Hours Worked HW 6
Time saved (hrs) TS 3
Rate per hour RH 150
Material M 160
0

10
4
 Solution

Rowan System:
E = HW * RH + (TS * HW * TA 9
RH) HW 6
TA TS 3
= 6 * 150 + (3 * 6 * 150) RH 150
9 M 160
= 6 * 150 + (300) 0
= 900 + 300 = 1200

Halsey System:
E = HW * RH + (50% * TS *
RH)
= 6 * 150 + (0.5 * 3 * 150) =
900 + 225 = 1125

10
5
 Methods of Wage Payment

10. Group Bonus Plan:

At times the output in a firm is measured in terms of group
performance. In such cases, group bonus system is implemented.
The total amount of bonus is determined according to productivity.
This can be shared equally or in agreed proportion among the group
members.
The advantages of this plan are as follows:
• Developing team spirit among workers
• Most effective utilization of materials and time
• Group efforts receive better focus and help in productivity

The group bonus can be budgeted expenses bonus where the

bonus is determined based on the savings in actual total expenditure
as compared with the budget level expenditure.
10
6
 Methods of Wage Payment

11.Priestman’s Bonus Plan:

• Under this method, the standards for output are pre-determined

and if actual production exceeds the standard level of output, a
fixed percentage of bonus is paid on the excess output.
• The amount of bonus is distributed among the workers in the
particular production unit.
• The limitation of this is that it doesn’t differentiate amongst
efficient and inefficient workers.
• This method is generally implemented in foundries.

10
7
 Methods of Wage Payment

12. Towne Profit Sharing Plan:

• Under this plan, the standards are fixed particularly for labour
costs and then actual costs are compared with the fixed
standards.
• If there is a saving in the cost, the saving is shared by the
workers and the supervisors in an agreed proportion.
• The concept is that if there is a saving in the cost, not only the
workers but also the supervisory staff must be rewarded since the
cost reduction occurred due to joint efforts.

10
8
 Methods of Wage Payment

13. Non Monetary Incentives:

• Many firms introduce non monetary incentives. These incentives are

given in addition to the monetary incentives to encourage the
workers and motivate them to contribute more effectively.
• The benefits may not result in additional remuneration to workers but
they certainly help to improve better participation.
• Some of the usually practiced non-monetary incentives
include free education and training, medical benefits, subsidized
canteen facilities, superannuation benefits like pensions, gratuity,
life insurance schemes, sports and recreation facilities, housing
facilities, etc.

10
9
 Methods of Wage Payment - Summary

TYPE FEATURES
Time rate at high day Very high time rate used to
incentivise workers
Graduated time rate Wages are paid at different time rates
Taylor’s differential piece Workers are classified as efficient
rate and inefficient
Gantt Task Bonus Plan Combination of Time Rate, Bonus
and piece rate
Halsey Premium Plan Bonus on 50% of time saved
through efficiency
Rowan Plan Premium bonus plan for the time saved
Group Bonus Plan Measures performance of a
group of workers

11
0
 Key Words
 Indirect Labour Cost: Expenses incurred on the workers who are not
directly connected with the production process
 Labour Turn Over: The frequency of the movement of the workers
from one organization to another
 Idle Time: The time spent by the workers without work
 Clock- Card: A time recording mechanism of the workers
 Piece Rate System: A wage rate system where workers are paid on the
basis of output
 Incentive Wage Plans: A process which links incentives to the production
 Payroll Department: A department in a firm involved in preparing
payrolls for workers
 Time rate System: A system of wage payment where wages to
workers are paid according to time spent in factory
 Group Bonus Plan: A plan whereby bonus for productivity is paid to
all in group
11
1
 Quiz Time

Q1. Which department prepares wage

sheet?
a. Time – Keeping Department
b. Personnel Department
c. Payroll department
d. Engineering department

Answer: C Payroll department

11
2
 Quiz Time

Q2. Which of the following plans does not guarantee wages on time
basis ?
a. Halsey plan
b. Rowan plan
c. Taylor’s differential piece rate system
d. Gantt’s task and bonus system
Answer: C Taylor’s differential piece rate system

11
3
 Cost and Management Accounting
Session 4

Chapter No 4 Overhead Cost Control

 What are Overheads?

• Overheads are those costs which are not identified with any
product
• Overheads are a common cost comprising of indirect material,
labour and expenses
• The overheads are apportioned to the cost unit

1
1
 Classification of Costs into Fixed and Variable

Advantages:
1.Controlling expenses: Classification into Fixed and Variable
components helps in controlling expenses. Fixed costs are generally
policy costs which cannot be easily reduced. They are incurred
irrespective of the output and hence are more or less non-
controllable. Variable expenses vary with the volume of activity and
the responsibility for incurring such expenditure is determined in
relation to the output. The management can control these costs by
giving proper allowances in accordance with the output achieved.
2.Preparation of Budget estimates: The segregation of overheads into
fixed and variable part helps in the preparation of flexible budget. It
enables a firm to estimate costs at different levels of activity and make
comparison with the actual expenses incurred

1
1
 Classification of costs into Fixed and Variable

Advantages:
3. Decision Making: The segregation of semi variable costs between
Fixed and variable overhead also helps the management to take
many important decisions.
For eg : The decisions regarding the price to be charged during
Depression or Recession or for export market
Likewise decisions regarding Make or Buy, Shut down or continue are
also taken after separating Fixed cost from Variable cost
When any important change is contemplated, for eg increase or
decrease in production/ change in the process of manufacture or
distribution , segregation of Fixed and Variable cost enables us to
ascertain the total impact on cost or revenue. The technique of
marginal costing, cost-volume-profit relationship and Break-even
analysis are all based on such segregation
1
1
Accounting and Control of Manufacturing Overheads

Overheads: Costs which, by nature, are such costs which

cannot be directly related to a product or to any other cost unit.
Yet for working out the total cost of a product or a unit of
service, the overheads must be included. Hence, we have to find
out a way by which the overheads can be distributed over the
various units of production
Manufacturing Overheads
Generally, manufacturing overheads form a substantial portion
of the total overheads. It is important that such overheads
should be properly absorbed over the cost of production to
arrive at the Factory cost of the unit.

1
1
Accounting and Control of Manufacturing Overheads

Let us understand about Factory Overheads :

1. Estimation and collection of manufacturing
overheads
2. Cost allocation
3. Cost Apportionment
4. Cost Re-apportionment
5. Absorption
6. Under-absorption and Over-absorption treatment

Detailed explanation follows

1
1
Accounting and Control of Manufacturing Overheads

1. Estimation and collection of manufacturing overheads:

The first stage is to estimate the amount of overheads, keeping in

view the past figures and adjusting them for known future changes.
There are four main sources available for the collection of factory
overheads, viz.:
(a) Invoices
(b) Stores requisition
(c) Wage analysis book
(d) Journal entries

12
0
Accounting and Control of Manufacturing Overheads

2. Cost allocation:
The term "allocation" refers to assignment or allotment of an entire
item of cost to a particular cost center or cost unit. It implies
relating overheads directly to the various departments.
The estimated amount of various items of manufacturing overheads
should be allocated to various cost centers or departments. For
example: If a separate power meter has been installed for a
department, the entire power cost ascertained from the meter is
allocated to that department.
The salary of the works manager cannot be directly allocated to
any one department since he looks after the whole factory.
It is, therefore, obvious that many overhead items will remain
unallocated after this step

12
1
Accounting and Control of Manufacturing Overheads

3. Cost apportionment:
There are some items of estimated overheads (like the salary of the
works manager) which cannot be directly allocated to the various
departments and cost centers.
Such un-allocable expenses are to be spread over the various
departments or cost centers on an appropriate basis.
This is called apportionment.
Thus apportionment implies "the allotment of proportions of items of
cost to cost centers or departments."
After this stage, all the overhead costs would have been either
allocated to or apportioned over the various departments.

12
2
Accounting and Control of Manufacturing Overheads

4· Re-apportionment:
All overheads are allocated and apportioned to all the
departments, both production and service departments.
Service departments are those departments which do not directly take
part in the production of goods. Such departments provide ancillary
services. E.g. boiler house, canteen, stores, time office, dispensary etc
The overheads of these departments are to be shared by the
production departments since service departments operate primarily
for the purpose of providing services to production departments.
“The process of assigning service department overheads to production
departments is called reassignment or reapportionment “ At this stage, all
the factory overheads are collected under production departments

12
3
Accounting and Control of Manufacturing Overheads

5. Absorption:
After completing the distribution, the overheads charged to the
department are to be recovered from the output produced in respective
departments.
This process of recovering overheads of a department or any other
cost center from its output is called recovery or absorption.
The overhead expenses can be absorbed by estimating the overhead
expenses and then working out an absorption rate.
When overheads are estimated, their absorption is carried out by
adopting a pre-determined overhead absorption rate.
There are different methods basis which this rate can be calculated
(to be discussed later)

12
4
Accounting and Control of Manufacturing Overheads

6. Treatment of over- and under-absorption of overheads:

After a year ends, the total amount of actual factory overheads is
known.
There is bound to be some difference between the actual amount of
overheads and the absorbed amount of overheads. So the overheads
are generally either under-absorbed or over-absorbed.
The difference has to be adjusted keeping in view of such differences
and the reasons thereof. This serves the following two purposes:
1. To charge various products and services with an equitable portion
of the total amount of factory overheads.
2. To charge factory overheads immediately as the product or the
jobis completed without waiting for the figures of actual factory
overheads

12
5
 Basis of Overhead Allocation

Overhead Cost Bases of Apportionment

Rent and other Floor area or volume of
building expenses each department
Lighting and
Heating Fire safety
Air conditioning
Perquisites Number of Workers
Labour welfare
Time keeping
Personnel
Office
Supervision
Compensation to Direct wages
workers Holiday pay
ESI & PF contribution
Perquisites
General Overheads Direct labour hours/
Direct wages/ machine
hours 12
6
 Basis of Overhead Allocation

Overhead Cost Bais of Apportionment

Depreciation of Plant and Capital Values
Machinery Repair and
maintenance of P&M
Insurance of stock
Power / Steam consumption Technical estimates
Internal transport
Managerial Salaries
Lighting expenses Number of lighting points
or area or metered unit
Electric power Horse power of machines
or number of machine
hours or value of units
consumed
Material Weight of materials or volume
handling Stores of materials or value of
overhead materials or units of material
12
7
 Difference Between Allocation and Apportionment

1. Allocation deals with the whole items of cost which are identifiable
with any one department. For example, indirect wages of three
departments are separately obtained and hence each department
will be charged by the respective amount of wages individually.
2. On the other hand, apportionment deals with the proportions of an
item of cost, for example, the cost of the benefit of a service
department will be divided between those departments which has
availed those benefits.
3. Allocation is a direct process of charging expenses to different cost
centers, whereas apportionment is an indirect process because
there is a need for the identification of the appropriate portion of
an expense to be borne by the different departments benefited.
4. The allocation or apportionment of an expense is not dependent
on its nature, but the relationship between the expense and
the cost center decides that whether it is to be allocated or
apportioned.
12
5. Allocation is a much wider term than apportionment
8
Methods of Absorbing Overheads to Various Products or
Jobs

1. Total amount charged (or recovered) in a period does not differ

materially from the actual expenses incurred in the period.
2. Amount charged to individual jobs or products is equitable. In
case of factory overhead, this means that:
a) The time spenton completion of each job should be
taken into consideration.
b) A distinction should be made between jobs done by skilled
workers and those done by unskilled workers.
c) Jobs done by manual labor and those done by machines
should be distinguished

12
9
Methods of Absorption of Overheads

13
0
Types of Overhead Rates

21
 Types of Overhead Rates

Pre Determined Overhead Rate

The amount of overhead rate of expenses for absorbing
them to production may be estimated on the following
three basis:
1. The figure of the previous year or period may be
adopted as the overhead rate to be charge to
production in the current year. The assumption is that
the value of production as well as overheads will
remain constant or that the two will change
proportionately.
2. The overhead rate for the year may be determined
on the basis of estimated expenses and anticipated
volume of production activity.
For instance, if expenses are estimated at Rs. 10,000 and
output at 4,000 units, the overhead rate will be Rs. 2.50
per unit.
13
3. The overhead rate for a year may be fixed on the basis 2
 Types of Overhead Rates

Blanket Overhead Rate

Blanket overhead rate refers to the computation of one single
overhead rate for the whole factory.
It is to be distinguished from the departmental over head rate
which refers to a separate rate for each individual cost center or
department.
The use of blanket rate may be proper in certain factories
producing only one major product in a continuous process or
where the work performed in every department is fairly
uniform or standardized.
A blanket rate should be applied in the following cases:
1. Where only one major product is being produced.
2. Where several products are produced, but
a) All products pass through all departments
b)All products are processed for the same length of time
in each department.
Where these conditions do not exist, departmental rates
13
should be used. 3
 Types of Overhead Rates

Departmental Overhead Rate

It refers to the computation of one single overhead rate for a
particular Production unit or department.

Where the product lines are varied or machinery is used to a

varying degree in the different departments, that is, where
conditions throughout the factory are not uniform, the use of
departmental rates is preferred.

13
4
 Problems and Solutions
Question: The following particulars relate to the production
department of a factory for the month of Jan 2020 :
Description Rs. Hours
Material Used 80,000
Direct Wages 72,000
Direct Labour hours 20,000
Machine operation hours 25,000
Overhead charged/allocated 90,000

Cost data of a particular work order carried out in the above

department during January 2020 are given below :
Description Rs. Hours
Material used 8,000
Direct wages 6,250
Direct labour hours booked 3,300
Machine operation hours booked 2,400
13
5
What would be the factory cost of the work order
under the following methods ?
1. Direct Labour Cost Rate
2. Machine Hour Rate
3. Direct Labour Hour Rate

13
6
1) Direct Labour Hour Rate Method:

Direct labour hour rate = Overhead chargeable to the department

Labour hours worked

= 90000 = 4.50Rs.
20000

2) Percentage of Direct Wage Rate Method

Percentage of direct wages Overhead chargeable to the department x 100

=
Direct wages

= 90000x 100 = 125

%
72000

3) Machine hour rate

method
Machine hour rate = Overhead chargeable to the department
Hours of machine operation

= 90000 = 3.60Rs.
25000 13
7
Comparative Statement of Cost
of Order

Particulars Direct Percentage Machine

labour of direct hour
hour rate wages rate
Material used 8000 8000 8000
Direct wages 6250 6250 6250
Prime cost 14250 14250 14250

Rs. 4.50 per hour for 3300 labour 14850

hours
125% of direct wage 7812.5
Rs.3.60 per hour for 2400
machine hours 8640
29100 22062.5 22890

13
8
 Numerical
We have the following information for January
2020
Description Brand A Brand B Brand C Brand D
Actual Production (units) 6,750 18,000 40,500 94,500
Direct Wages (Rs.) 15,000 27,500 37,500 105,000
Direct Material Cost (Rs.) 50,000 92,500 127,500 380,000
Selling Price per unit 20 15 10 8

Factory overhead expenditure for the month : Rs.162,000

Factory overhead expenses to be allocated to each brand on
the basis of Direct Labour Cost Rate
Selling and Distribution cost : 20% of Works Cost
We need to compute the Brand-wise Direct Cost, Works Cost,
Total Cost and Profit for the month (assuming all units are
sold)

13
9
Computation of Factory Overhead allocation based on the direct
labour cost rate
(Overhead/Total Direct wages) * 100 = (162000/185000)*100 =
87.57%
Description Brand A Brand B Brand C Brand D
Actual Production (units) 6,750 18,000 40,500 94,500
Direct Wages (Rs.) 15,000 27,500 37,500 105,000
Direct Material Cost (Rs.) 50,000 92,500 127,500 380,000
Direct Cost 65,000 120,000 165,000 485,000
Factory overhead @ 13,135 24,081 32,838 91,946
87.57% of Direct Wages
Works Cost 78,135 144,081 197,838 576,946
Selling and Distribution @ 15,627 28,816 39,568 115,389
20% of Works Cost
Total Cost 93,762 172,897 237,406 692,335
Selling Price per unit 20 15 10 8
Revenue (SP * Units) 135,000 270,000 405,000 756,000
Profit 41,238 97,103 167,594 63,665
14
0
 Quiz Time

Q1. The allotment of whole items of cost of centers or cost

unit is:
a. Cost allocation
b. Cost apportionment
c. Overhead absorption
d. None of the above

Answer: A: Cost allocation

14
1
 Quiz Time

Q2. Which of the following methods of absorption of factory overheads is

suitable for a firm that produces single and uniform type of product ?
a. Percentage of Direct wages basis
b. Direct labour rate
c. Machine hour rate
d. Rate per unit of output

Answer: D: Rate per unit of

output

14
2
 Key Words

Overhead: Indirect expenses incurred in production process.

Factory overhead: The expenses in the production process.
Selling overheads: Expenses incurred on selling and distribution
process. Absorption: The allocation of overheads.
Absorption rate: The rate at which overheads are absorbed as per
unit basis.
Direct labor hour rate: When actual overheads are divided by actual
labor hours.
Over absorption: When overheads absorbed in a product are more
than the actual overheads incurred.
Administration overheads: Expenses incurred in carrying out
administrative functions

14
3
 Summary

 Besides Material and Labor cost, Overhead costs form an

important part of total product cost
 Overhead costs are indirect expenses involved at every stage
of the product lifecycle including production process,
administrative stage or selling and distribution activities
 The proper categorization of Overheads is important to
allocate and absorb them under the most relevant category as
this directly affects the cost of the product
 The overhead absorption policy of a firms impacts the
costing of a product thereby impacting the pricing and
consequently the profitability of the product

14
4
 Cost and Management Accounting
Session 5

Chapter No 4 Cost concepts, Cost classification and Unit

cost analysis
 Concept of Management and Cost accounting – An
introduction

All businesses are concerned about revenues and costs

• Managers at companies, small and large must understand
how revenues and costs behave or risk losing
control of the performance of their firms
• Managers use cost accounting information to make
decisions about research and development,
budgeting, production planning, pricing and the products
or services to offer customers. Sometimes these decisions
involve tradeoffs.
Management accounting assists Managers in taking such decisions
to optimize the revenues and minimize the costs

1
4
 Cost – Terminologies

Cost: In the normal parlance, cost is the expenditure incurred on a

particular product or service.
However, according to the Cost accounting system, cost is defined
as the resources sacrificed or given up to achieve a goal or defined
purpose.
It can also be defined as the expenditure incurred or attributable to a
given object
Expense: An expense is an element of cost incurred and is measured
when an asset is sold or disposed off, for generating revenue out of it.
As long as the product remains as an inventory, it is called value of
inventory or cost of inventory. The moment it is sold, the product cost
is recognised as an expense and is called “ Cost of Goods Sold”.

1
4
 Cost – Terminologies

Revenue: It is the total sales value a firm generates from

the sales of products and services in a particular period of
time.
It is also known as Sales revenue. The total revenue equals
sales revenue plus receipts from sale of other assets.
Income: Revenue less expenditure is equal to income.
Depending on the nature of Income, it is further
classified into different categories.
Overhead: These are commonly shared costs such
as maintenance, depreciation, utilities and other common
costs.
The overheads are allocated to different products
based on certain criteria
1
4
 Classification of Costs

1. According to components
2. According to Nature
3. According to Behaviour
4. According to Function
5. According to Controllability
6. According to Management
Decisions
7. According to Expiry

1
4
 Classification of Costs – According to its Components

1. Material Cost:
It is the cost of acquiring raw materials to be used for a finished
product or the materials consumed in the process. This helps to
produce a product for sale.
It can be direct material that is consumed in the manufacturing
process and physically used for the finished product. It can be traced
out to the product.
It can also be indirect material cost . This is also required for the
production process, but cannot be directly attributed to the product.
The expenses on cotton waste, lubricating oil, etc., can be classified as
indirect materials. If the cost of materials is insignificant, it can also
be classified as indirect.

1
5
 Classification of Costs – According to its Components

2. Labour Cost:
• The amount paid to workers as wages and salaries are classified as
labor cost. It also involves all the benefits passed on by the firm to
the workers when wages are paid to the workers who are
directly involved in the production process, that is, converting ,
materials into finished products is called direct labor cost.
• This involves all kinds of workers, skilled and unskilled.
• There is another component which may include salary/wages being
paid to workers who do work directly on the product, but their
services are necessary for production process. This is termed as
indirect labor cost.
• Wages salaries paid to supervisors, security guards, purchase and
store staff etc., are indirect labor costs

9
 Classification of Costs – According to its Components

3. Expenses:
The amount spent for completion of manufacturing process other
than Materials and labour cost are classified as expenses.
Direct expenses can be directly allocated to the specific process,
product or service.
The expenses that cannot be directly attributable to a product or
service are called indirect expenses.
Eg : Factory rent, Store expenses, Factory Manager’s salary

15
2
 Classification of Costs – According to Nature

The costs can be classified as Direct and Indirect costs

Direct Costs:
•The costs that are identifiable or attributable to a particular
product/unit are direct costs.
•The costs such as purchase of material, direct wages to labour
and direct expenses associated with a product or process are Direct
expenses.
Indirect costs:
• These are not identifiable or attributable with the product / unit.
•These are allocated, apportioned and absorbed in the production
cost on the basis of their use

15
3
Classification of Costs – According to Behaviour

15
4
 Classification of Costs – According to Behaviour

1. Fixed Costs:
•The costs that remain fixed up to a particular level of
Production irrespective of changes in the production
volume are known as fixed costs.
•The peculiarity of fixed cost is that the total costs remain
same while per unit fixed cost comes down with the
increased level of production.
•Examples of fixed costs are depreciation, salaries,
insurance, rent, etc

15
5
 Classification of Costs – According to Behaviour

2. Variable Costs:
 These costs change according to the volume of production.
 If the production volume is higher, the variable cost will be
more and vice versa. This change occurs in proportion.
 The features of variable costs are that per unit variable
cost remains the same whereas the total variable cost
will change with production.
 Some of the examples of variable costs are direct materials,
direct labor and direct expenses

15
6
 Classification of Costs – According to Behaviour

3. Semi - Variable Costs:

• When certain components of the total cost of a unit/activity are

fixed and remaining components depend on the use of that activity,
it is called semi- variable cost.
• In other words, semi-variable cost contains the features of both,
fixed and variable costs.
• In this case, the fixed part does not change while the variable
component depends on the use.
Examples of semi variable costs:
• Telephone bill
• Electricity bill
• Contractual salaries to supervisors, etc.
• Salary of Salesmen, Fixed plus incentivesRole

15
7
 Classification of Costs – According to Behaviour

4.Stepped Fixed cost:

When costs are fixed up to a certain level of activity and
then
increased by fixed amount with further rise in the level
of
activities, it is called stepped fixed cost.
For example, the fixed cost upto 1000 units of output of a
product is Rs 5,000 and thereafter for the next level up to
1,000 units, the cost will rise by Rs.2,000.

15
8
 Classification of Costs – According to Function

1. Production or Manufacturing Costs: All costs incurred in the

production process and producing a finished product are called
production costs.
The elements of production cost mainly include: Direct materials, Direct
labor
, Direct expenses and overheads in connection with the
production or manufacturing activities
2.Administration Costs: Costs that are incurred in managing
general administration activities and that cannot be directly related
to production marketing and other activities are called administration
cost.
3.Selling and Distribution Costs: The costs incurred on publicity,
advertising, salesman’s salaries and travelling expenses etc are
examples of selling costs. Costs incurred on delivering products and
other related activities are called distribution costs. Distribution cost
involves transport cost, packaging, etc. Sometimes15 in case of
9
 Classification of Costs – According to Function

4.Finance costs : The costs associated with external borrowed funds

such as interest paid or accrued on borrowed funds
5.Research and Development costs: The cost incurred on research
and Development activities for new innovation and techniques,
which result in increased efficiency of the products and processes
are called research and development costs.
6.Pre-production Costs: The preliminary cost incurred on trial, testing
and production before normal and regular production is called pre-
production cost. This is different from research and Development cost
and basically incurred on testing a product before going into final
production

16
0
 Classification of Costs – Based on Controllability

Controllable:
•The costs that can be influenced by decisions of management and
can be controlled are known as controllable costs.
•It means the management can reduce, minimize or avoid this cost
base on its own decisions.
•Direct costs generally fall under this

category. Uncontrollable:
•The costs that cannot be influenced by the decisions of the
management are uncontrollable costs.
•Short-term commitments such as salaries and maintenance
are uncontrollable costs

16
1
 Classification of Costs – By Management Decisions

1. Marginal Cost:
• The cost incurred in producing one additional unit is called marginal
cost.
•It is total variable cost as when we produce one additional unit,
variable cost alone is incurred as the fixed component remains the
same.
•Marginal revenue and marginal cost, both are significant for taking
a decision to produce or not to produce
•The rule is as long as marginal revenue is equal or more than the
marginal cost, a firm goes on producing

16
2
 Classification of Costs – By Management Decisions

2. Opportunity Cost:
•The amount sacrificed or foregone to achieve a better option is
called opportunity cost.
•It is used when a firm needs to make a choice between more than
one option and has to choose the best.
•If a firm has surplus funds for a short-term period, it has different
options to invest in. It chooses the best one by sacrificing or foregoing
the others

16
3
 Classification of Costs – By Management Decisions

3.Differential Cost: ·
It is also known as incremental cost, which is required to be incurred if
a firm needs to choose other alternatives of production or any other
changes in the level of production etc. ·
What will be the difference in the total cost if the firmwants to add or
drop out a product? ·
Such decisions are taken keeping in view the increased costs. ·
Even vital decisions to buy a product from the market or to produce
on its own are also influenced by the differential cost concept.

16
4
 Classification of Costs – By Management Decisions

4. Imputed or Notional Cost :

 When a firm utilizes its own resources such as building and
capital, the cost of these components is not accounted for. ·
 For example, rent on own building or interest on own capital
in not considered when we prepare profit and loss account. ·
 But these kinds of costs are considered while taking managerial
decisions because in that scenario alternative investment
decisions can be considered. ·
 Therefore, the cost that does not appear in financial accounting
but is considered only for managerial decisions is called imputed or
notional cost

16
5
 Classification of Costs – By Management Decisions

5. Discretionary Cost:
 This cost is fixed in nature and incurred on the basis of policy
decisions of the management.
 It does not affect the current level of production. The
examples of discretionary costs are:
 Training to employees
 Additional research and development activities
 Advertisement costs etc.
Since all these costs to be incurred or not to be incurred depend
on the discretion of Management, they are called discretionary
costs. These are also known as programmed costs or managed
costs or policy costs.

16
6
 Classification of Costs – By Management Decisions

6.Out-of-pocket cost: All costs that involve cash outflow are called
out-of- pocket costs. There are certain costs like depreciation that
does not require any cash outflow and therefore is not termed
out-of-pocket cost. The significance of this cost is that it helps
management in deciding the level of cash to be arranged at different
intervals.
7.Sunk costs: The cost committed in the past due to wrong
managerial decisions does not yield any revenue in the present is
called sunk cost. Suppose a young engineer entrepreneur, who is
enthusiastic and optimistic, wishes to establish a unit of production.
For this purpose, he avails a piece of land at a rent of Rs 2 lakhs p.a .
Later on he realizes, just 50% of the land is sufficient to continue the
production for the next 3 years. In this case, the rent being paid on the
vacant piece of land is called sunk cost

25
 Classification of Costs – By Management Decisions

8.Relevant Cost: All costs may not be relevant for taking future
decisions as under different alternatives and scenarios, certain existing
costs may not be relevant. We can think of a firm deciding about
acquiring an automated plant that may not have any manual work. In
this case, all existing costs relating to manual operations become
irrelevant. Therefore, the management decides which of the costs
are relevant and they alone are considered for future decisions.
9.Replacement cost: The cost associated with replacing a present
asset is called replacement cost. Suppose a firm wishes to
replace its existing machinery and plant and if the cost is Rs. 20
lakh and the present machine has a saleable value or Rs. 4 lakh, the
replacement cost will be Rs 16 lakh

16
8
 Classification of Costs – By Management Decisions

10. Abnormal cost: When a cost occurs on account of reasons or

circumstances beyond control, not in normal or routine course, it is
called abnormal cost.
There may be instances of additional production cost due to fire in the
plant, break down of machinery, power failure etc., that may cause
an increase in the cost.
The abnormal cost is not included in the production cost but is
adjusted in profit and loss account.
It is because the product manager is primarily responsible for
normal loss only

16
9
 Classification of Costs – By Management Decisions

11.Shutdown cost: Sometimes a unit remains shut without any

operation for a temporary period on account of strikes by the workers,
recession demand or any other reason. After some time; the unit
starts functioning again. The costs, such as wages to security,
depreciation and sheltering of plant, that are incurred during this
period when the unit remains closed and the cost, such as oiling and
overhauling of machines and parts, incurred again when the unit
starts functioning are called shutdown costs.
12.Capacity Cost: A fixed cost in nature that is incurred in creating
certain facilities on long-term basis for smooth functioning of various
operations such as plant, machinery, building warehouses and
distribution arrangements, is called capacity cost

17
0
 Classification of Cost based on Expiry

All historical costs are either classified as expired costs or unexpired costs.
Unexpired costs are the costs incurred in acquiring resources and
creating facilities and capacities to generate revenues for a firm in
future.
These costs are a part of assets in the balance sheet of a firm. The
examples of unexpired cost are costs of machinery and equipment.
This cost becomes expired cost when rneasured in terms of expenses
to compare revenue.
Therefore, as long as an inventory of finished stock remains as
closing inventory in the balance sheet, it is unexpired cost but
the moment it generates revenue for the firm, the historical cost
becomes expired cost.
Cost is also defined as resources sacrificed to achieve a goal.
Therefore, cost incurred in creating facilities is unexpired cost
17
1
 Classification of Cost based on Expiry

Product and period costs:

Product costs: Product costs are attached to, and carried over
with the particular product. For example, consider Cellular products,
manufacturer of Cellular phones.
The cost of the company’s direct materials such as computer
chips, direct labor costs and manufacturing overheads create new
assets They start out as Work in process inventory and become
finished goods inventory ( the cellular phones).
When cellular phones are sold, the costs move from being assets to
cost of goods sold. This cost is matched against revenues, which are
inflows of assets received for products purchased by customers

17
2
 Classification of Cost based on Expiry

Period Costs:
All costs that are accounted for in a particular time period and not
carried over to another time period with the product are called period
costs.
These are recorded in the current year's profit and loss account.
Period costs such as Marketing, distribution and customer service
costs are treated as expenses of the accounting period in which
they are incurred because Managers expect these costs to increase
revenues only in that period and not future costs
For manufacturing sector companies, period costs in the income
statement are all non-manufacturing costs (for eg: Design and
distribution costs)

17
3
 Classification of Cost based on Expiry

Product cost – part of inventory, expensed when sold

Period cost – not part of inventory, expensed when incurred

The manufacturing cost of finished goods include direct materials,

other direct manufacturing costs such as direct labour and
manufacturing overhead costs such as supervision, production control
and machine maintenance.
All these costs are inventoriable; they are assigned to Work-in-
process inventory until the Goods are completed and then to finished
goods inventory until the goods are sold.
All non manufacturing costs such as R&D, design and distribution
costs are period costs.
This concept will be explained better when we deal with
absorption and marginal costing concept in Chapter
17 5 of this book
4
 Classification of Cost - Summary

Basis of Types of Costs

Classification
Components of Cost Material, Labour , Overheads and other expenses
Nature of Cost Direct and indirect
Behaviour of Cost Fixed, Variable and Semi Variable, Stepped Fixed Cost
Functions of Cost Production or Manufacturing, Administrative,
Selling and Distribution, Research and
Development, Pre- Production, Conversion
Controllability Controllable and uncontrollable
Normality Normal and Abnormal
Managemen Marginal, differential, imputed or notional,
t Decision opportunity, relevant, discretionary, sunk,
replacement, abnormal, shutdown, committed,
capacity,
Periodicity Historical and future
Expiry Expired and unexpired
3
Product/Period Cost Product/Period 3
COST S H E E T

17
6
 Cost Sheet

1.Prime cost: It is the sum of total direct costs and includes

cost of material actually consumed for a product in a particular
time period. Direct labor cost including the amount payable (due
but not paid) and other direct expenses incurred during the
period.
Direct material consumed + Direct labour + Direct expenses = Prime
cost
2.Factory cost or works cost If factory overheads are added
to Prime cost, we arrive at the total Factory cost. It means cost
of the product upto process at Factory. This is also known as
Factory cost gross. In this gross factory cost, if we add Opening
stock of WIP and subtract closing stock of WIP, we will the value
of the net Factory cost
Prime cost + Factory overheads + Value of opening WIP – Value of
closing WIP = Factory cost 17
7
3. Cost of production
So far we have arrived at factory cost as discussed previously but
there are administrative expenses also attached to a product and
therefore these are also considered while arriving at the cost of
production. Therefore, we add all administrative expenses in the factory
cost. Thus,
Cost of production = Factory cost + Administrative expenses
This gives the total units produced during the period and the
total cost thereof. These units are also called "finished goods."
Remember every firm has the opening stock of finished goods (which
is the closing stock of the last period) and also retains certain
units as closing stock from the total production . Therefore, to
arrive at the net value of finished goods that can be sold or are
available for sale for the particular period, we add the units and value
of opening finished stock and reduce the number units and value of
closing stock. Thus, COGS or Cost of goods sold = Cost of production
+ Value of opening finished stock- Value of closing finished stock
17
8
 4.Cost of Sale It can be noticed that COGS attaches the value of
finished stock available for sale and so far we have not considered
the selling and distribution expenses that are required to be incurred
in selling the available units for sale. To arrive at the cost of sale,
all the connected Selling and distribution expenses are added to the
value of COGS. Thus,
Cost of sale = COGS + Selling and distribution expenses

5.Selling Price Once the final value of cost of goods is available per
unit we add the profit margin to fix the selling price. Therefore
Selling price= Cost of sale per unit x Profit margin (percent) per unit.
Suppose the cost of sale per unit is Rs.40 and as per the firm policy,
profit margin is 15%, the selling price per unit will be R.s 46.
Sometimes the profit is calculated at the selling price. In that case,
the percentage of profit is increased on cost per unit

17
9
 Cost Sheet
1. Prime cost: Direct Material
Consumed
+ Direct Labour Cost
+ Direct Expenses

2. Factory/ Works= Prime Cost

cost:
Prime Cost
+ Factory Overheads
+ Value of opening
WIP
- Value of Closing WIP
= Factory Cost
3. Cost of production:
Factory Cost
+ Admin Expenses
= Cost of Production
18
0
4. Cost of Goods Sold (COGS) :
Cost of Production
+ Value of opening Finished
Stock
- Value of closing Finished stock
= Cost of Goods Sold
5. Cost of sale: COGS
+Selling and Distribution Expenses
= Cost of Sale
6. Selling price = Cost of Sale per Unit * Profit Margin (%) per
Unit

18
1
 Advantages of the Cost Sheet

1. A firm can monitor the cost of product at each stage of

production as break-up figure of total cost as well as per unit cost is
available in the cost sheet statement.
2. The cost sheet also provides information of the cost in a
particular time period. This helps a firm to compare the cost in
different intervals of time and check whether the cost escalation is
justified.
3. Based on the trends of cost available over a period of time,
future projections can be made with certain accuracy.
4. More importantly, it helps a firm to determine selling price in a
more reasonable manner as cost sheet considers all components of
actual costs.
5. Cost sheet consists of all adjustments such as WIP, opening and
closing finished, scrap value from wastage, etc. The cost arrived at
on the basis of this is fairly accurate 18
2
 Treatment and Adjustments of certain cost components

There are some costs related to transactions that need to be

treated separately in the cost sheet to arrive at a far more
accurate cost of the product. Some costs and their adjustments in the
cost sheet are given below:
1. Value of scrap: Generally scrap or wastage occurs at two places,
either at the materials storage place or in the production process. The
scrap so occurs is sold and that is called scrap value. The scrap
value reduces the cost of production to an extent. Therefore, the
value of scrap is deducted from the direct material cost if the wastage
had occurred at material storage place and from the factory cost if the
wastage occurred in the production process. Thus, more accurate cost
is obtained. If it is not specified where the wastage occurred, the
scrap value is deducted from the factory cost as it is generally
assumed that wastage happens in the production process. Suppose the
factory cost of a product is Rs.12.55 lakh and the scrap is sold for
Rs. 2 lakh of a particular product, in that case the treatment will be
as follows: • Factory cost: Rs. 12.55 lakh • Less: Scrap value Rs. 2
lakh • = Net factory cost: Rs. 18
3
10.55 lakh
Treatment and Adjustments of certain cost components

2. Loss of Material:
There may be instances of losses of raw material. Such losses are
categorized into two categories:
1) Normal loss that occurs in natural process of materials handling
Normal loss is automatically charged to material cost as no
separate treatment is needed
2) Abnormal loss that occurs due to fire, accidents, etc.
Abnormal cost should be deducted from the value of raw material
purchased so that effective cost of raw material consumed could be
obtained

18
4
Treatment and Adjustments of certain cost components

3. Bad Debts:
• When a sale is made on credit, there happens to be bad
debts.
overhead
•Sometimes,
The amount of bad
bad debts may debt
occurshould be absorbed
on account in reasons.
of abnormal s.
selling
• In that case, the amount should be debited to profit and loss account.

4. Trade Discount:
It is a part of sales revenue, and the discount offered brings down the
value of sales revenue to that extent that it should be deducted from
the sales revenue to obtain net sales value.

18
5
Treatment and Adjustments of certain cost components

5.Packing charges: Treatment of packing charges depends on the

purpose of packing.
Material Cost: Packing cost important for the product
Factory Cost: Packing for movement of stock from one place to another
during production process
Selling and Distribution cost: Packing cost for transportation of
goods If it is not specified, then it should be added to selling
expenses.
6.Octroi, Customs duty etc: All costs associated with the
purchase of materials including taxes, octroi, customs duty, etc., and
carrying costs are included in direct material costs.

18
6
Treatment and Adjustments of certain cost components

7. Factory Stores: A factory store is a storage room where

necessary production process equipment, lubricants and other
components required in a routine manner are stored. These
components are stored on an ongoing basis to continue the production
process. Therefore, the treatment of factory store overheads is done in
the following manner:
Opening stock of factory stores
Add: New purchases during the period
Less: Closing value of factory stores components
= Net factory stores to be added to factory overheads

18
7
Treatment and Adjustments of certain cost components

8.Donations:The treatment of donations is done depending on

the purpose of donation .
If it helps in boosting the sales of the product, it will be added to
selling and distribution expenses otherwise it should be accounted in
profit and loss account.
9.Interest on Capital:
Not to be included in the cost sheet.
It should be accounted for in the profit and loss account

18
8
 Valuation of Closing Stock

1. Valuation under First in First Out method (FIFO): • Under FIFO method
of valuation, it is presumed that units of finished stock received
first ( closing stock of last period) are sold first. • Therefore, the
total cost of production is divided by the number of units produced
during the period and then it is multiplied by the units of
closing inventory during the current period since the units received
as opening stock are already out.
2. Valuation under Last in First Out method (LIFO) • Under this method,
it is assumed that units produced last are sold out first.
Therefore, the closing stock units of current period consist of both,
the units received as opening stock from the last process and
remaining for this period. • Suppose the closing units of finished
stock in a particular time period are 1,000 and opening units of
finished stock are 400. In this case, while measuring the value
of closing stock, the 400 units will be valued at the opening stock
valued carried over from the last process and remaining 600 units
will be valued at the current period cost. 18
9
 Valuation of Closing Stock

3. Average cost method:

In this case, the closing inventory is valued at an average rate, that
is, per unit cost of opening inventory plus per unit cost of current
closing inventory divided by two.
4.Weighted average method:
Under this method, weighted cost of opening and closing
inventory is considered.
The value of closing inventory can be arrived at in the following
manner: Value of closing inventory = Value of opening finished goods
+ Total cost of production in the current period/Number of units
under opening finished stock + Number of units in current production
x Number of closing units of finished stock

19
0
 Quiz

Q1 . Which of the items is not included in preparation of Cost

sheet ?
a. Carriage Inward
b. Purchase Returns
c. Sales Commission
d. Interest Paid

Answer: d. Interest Paid

49
 Quiz

Which of the following are Direct Expenses ?

• The cost of drawings, special designs or
layouts?
• The hire of tools or equipment for a particular
job
• Salesman’s wages
• Rent, rates and insurance of a factory
a. A and B
b. A and C
c. A and D

d.C and D

Answer: a. A and 19
2
 From the following information prepare a cost sheet.
Particulars Amount
(Rs.)
Direct material-purchased 80,000
N Direct material -Opening stock 20,000
U Direct material -Closing Stock 25,000
M Productive wages 22,000
E
Direct Expenses 5,000
R
Consumable stores 4,000
I
C Factory manager salary 15,000
A Unproductive wages 7,000
L Factory Overheads 12,000
Work in progress - Opening stock 13,000
Work in progress - Closing stock 7,000
Office and administration overheads 28,000
Opening stock of finished goods 5,000
Closing stock of finished goods 10,000
Selling and distribution overheads 33,000

Company desires a margin of 20% profit on the cost of sales

19
3
 COST SHEET FOR THE MONTH OF FOR XYZ.
AMOUNT
PARTICULARS AMOUNT
TOTAL
DIRECT MATERIAL-PURCHASED 80000
ADD OP STOCK OF RAW MATERIAL 20000
–
LESS CL STOCK OF RAW MATERIAL 25000
S MATERIAL CONSUMED 75000 75000
ADD DIRECT WAGES 22000
O ADD DIRECT EXPENSES 5000
L PRIME COST 102000
U ADD WORKS OR FACTORY OVERHEADS
Consumable stores 4000
T Factory manager salary 15000
I Unproductive wages 7000
Factory Overheads 12000 38000
O 140000
N ADD OP STOCK OF WIP 13000
LESS CL STOCK OF WIP 7000 6000
WORK COST 146000
ADMINISTRATION OR OFFICE
ADD 28000
OVERHEADS
COST OF PRODUCTION 174000
ADD OP STOCK OF FG 5000
LESS CL STOCK OF FG 10000 -5000
COST OF GOODS SOLD 169000
SELLING AND DISTRIBUTION
ADD 33000
OVERHEADS
COST OF SALES 202000
PROFIT MARGIN @ 20% ON COST OF
ADD 40400
SALES
SELLING PRICE 242400

5
2
 Cost and Management Accounting
Session 6

Cost Analysis: Job Order, Batch and Contract Costing & Income
Recognition under Marginal and Absorption costing
 Lecture Sub topics

1. Understand the concept of job costing in manufacturing units.

2. Understand measurement of costs in job costing system.
3. Determine economic batch quantity in batch costing system.
4. Understand the concept, measurement and estimation of cost
under contract costing system.
5. Understand the contract plus cost system.
6. Calculate the cost for certified and non-certified works under
contract costing

19
6
 Job Costing
A job is a customer specific order that is accepted and carried
outat
different levels in a workplace through different processes
and
operations for completion.
Work involved in each unit’s process on a particular job is
identifiable and cost associated with it can also be measured.
Once a particular job is completed, the cost of all activities/
units on this job is compiled to arrive at the Total cost of the job.
Job order costing is typically used in :
• Printing works
• Automobile servicing
• Engineering works
• Fabrication works etc
In the Job Costing system, an order or a unit, lot or batch of a
product may be taken as a Cost unit
19
7
 Process of Job Order Costing

 Receiving production/Job
order
 Acquiring materials
 Organizing labour
 Overhead costs
 Completion of final job

19
8
 Job Order Costing - Features

1. It is a customer-specific order costing.

2. The job is carried out as per the specific requirements of the
orders and according to desired specifications.
3. It may involve a single unit or a batch of similar units.
4. It is concerned with the cost of an individual order or batch
orders.
5. Cost details of all processes involved in job completion are
collected after the end of all processes

19
9
 Job Order Costing - Features

6.The cost of each job is measured by collecting details of

materials used, labour and overheads from different processes.
7.The common overheads are apportioned to each job based on the
overhead absorption method.
8. Work-in-progress may or may not be at the end of the accounting
period.
9.Sometimes a job order may extend to the next accounting period.
In such cases, cost will be limited to only one particular accounting
period.
10.Each job is treated as a separate
accounting unit; therefore, separate production numbers are
allocated.

20
0
 Advantages of Job Costing

1. Detailed analysis: The cost data generated is useful for further

analysis and control.
2. Ascertaining Profit or Loss: The firm can evaluate profit or loss
made on each job and compare the price tendered for the job.
3. Comparison with Standard cost: The cost so arrived can be compared
with standard costing.
4. Price Negotiation: If the firm is able to know the fair cost of a
particular job, it can bargain on the price of that job with the
customer.
5. Comparison: It helps in making a comparison with performance on
other jobs.
6. Cost control measures: As the expected cost data is available, the
firm can take collective measures to control the cost before the job
is completed, as any mistakes or excessive costs show up at an early
20
stage 1
 Limitations of Job Costing

1. Since implementation of job costing needs all details of resources,

records and cost details, it is time consuming as well expensive.
2. Keeping detailed records of individual jobs is a complicated process.
3. It is useful only for small and short-term job orders where too
many processes or components are not involved.

20
2
 Examples of Job Costing in Service Merchandising
and Manufacturing Sector

 Manufacturing Sector:
 Assembly of individual aircrafts at Boeing
 Construction of ships at Mazgaon Dock
 Merchandising Sector:
 Sending individual orders by mail order
 Service Sector:
 Audit Engagements done By Price Waterhouse Coopers
Consulting
 Individual legal cases argued by Wadia Ghandy
 Movies produced by RK Studios

20
3
Problems and Solutions

20
4
 Question 1: The following data has been taken from the books of
Rockstar Ltd for the year ending 31 March 2023
Particulars Amt (Rs.)
Direct Material cost 1,80,000
Direct Labour cost 1,50,000
Profit 1,21,800
Selling and Distribution Overheads 1,05,000
Administrative overheads 84,000
Required: Factory overheads 90,000

1. Job cost sheet detailing therein Prime cost, Works cost, Production cost,
Cost of Sales and Sales Value
2. The company has received an order for a number of jobs for the next
year. It is expected that the direct materials would cost Rs. 2,40,000
and direct labour would cost Rs. 1,50,000.
3. Compute the value for these jobs assuming that the firm targets to
earn the profit at same rate as in 2018-19 on Sales. Also consider
that the S&D overheads will increase by 15%. The firm recovers
Factory OH as a % of Direct wages and Admin and S&D OH as a % of
Works cost. 20
5
Solution: Job cost sheet for

Particulars Amount (Rs.) Amount (Rs.)

Direct Costs:
Direct Material Cost 1,80,000
Direct Labour Cost 1,50,000
Prime Cost 3,30,000
Add: Factory Overheads 90,000
Factory Cost 4,20,000
Add: Admin Overheads 84,000
Cost of Production 5,04,000
Add: Selling & Distribution OH 1,05,000
Cost of Sales 6,09,000
Add: Profit 1,21,800
Sales 7,30,800

Note: Profit is 20% of Cost of Sales =

(121800/609000)*100
20
6
 Arriving at the % of OHs to be charged for preparation
of quotation

Factory Overheads to Direct (90000/150000)*100 60%

Wages (as a % of Direct Wages)

Admin Overheads (as a % of (84000/420000)*100 20%

Factory cost)

Selling and Distribution (105000/42000) * 25%

overheads (as a % of Factory 100
Cost)

20
7
 Computation of Price Quotation for the Job

Particulars Amount Amount

(Rs.) (Rs.)
Direct Costs:
Direct Material Cost 2,40,000
Direct Labour Cost 1,50,000
Prime Cost 3,90,000
Add: Factory Overheads (60% of direct labour) 90,000
Factory Cost 4,80,000
Add: Admin Overheads (20% of works cost) 96,000
Cost of Production 5,76,000
Add: Selling & Distribution OH (25% of works 1,38,000
cost + 15% increase) i.e
(480000*25%)*115%
Cost of Sales 7,14,000
Add: Profit 1,42,000
Sales 8,56,000
20
8
 Batch Costing

When certain quantities of similar products are produced at one

time, it is known as Batch Production.
The concept of Batch costing is applied when certain quantities of
similar and identical products are manufactured together as one job.
Generally, the concept of Batch costing is applied in :
• Printing
• Packaging
• Manufacture of automobile and engineering components i.e when
there is mass production and the units are homogeneous
• The cost unit is a particular batch
• Cost is ascertained for the entire batch

16
 Batch Costing

Total Annual Cost of Production = Annual cost of set up + Annual

Holding cost
21
0
 Question

 A firm accepted an offer to supply 48,000 pistons per annum to

another firm
 The inventory holding cost per piston per month is 20 paise.
 The set up cost per run of piston manufacturing is Rs 648/-
 Compute:
1. Optimum run size for piston manufacturing.
2. Interval between two consecutive optimum runs.
3. Minimum inventory cost per annum

21
1
Solution – 1/3

21
2
Solution – 2/3

21
3
Solution – 3/3

21
4
 3. Contract Costing

Features of Contract Costing

1. In (contract) job costing, each contract is treated as a separate unit
of cost.
2. Each contract is allotted a specified number and the contract is
generally carried out at the site of customer.
3. Majority of expenses, which are identifiable with a specific
contract, are directly allocated to that contract. A few overheads
are allocated on the basis of the overhead absorption policy of the
organization.
4. In contract costing, sub-contracts are assigned for specified
jobs like welding work, electrical work and wood work;
therefore, costs are traceable and directly allocated to the
contract.

21
5
 Features of Contract Costing…Continued…

5. A contract work may run for more than one accounting year.
6. For completion of a contract, required plants and equipment can be
hired from different sources. Even services of experts and
consultants can be availed of.
7. A contract may have penalty provisions for noncompletion of work
in time or for not carrying out work as per pre-agreed specifications.
8. Another unique feature of contract costing is measurement of
profit on incomplete works. As per the accepted accounting
practices, in contract costing the profit on an incomplete work
should be calculated on accrual basis.

21
6
 Process of Contract Costing

The process of Contract Costing passes through the following phases:

1. Material Cost:
• The materials required to complete a particular contract are debited
to the related contract account.
• If the materials remain in stock at the end of the accounting the
period, are shown as closing stock and carried forward to the y
next period.
•2. Labour
Wages Cost:
paid to the workers engaged on a particular contract
should be charged to that contract irrespective of the work
performed by them.
• If there are common workers on more than one contract or if
workers are transferred from one contract to another one, time
sheets must be maintained and wages may be distributed based
on time spent on each contract
• Wages of workers working in Central stores/ office can be
apportioned to a particular contract on a suitable basis eg: Time
spent etc 21
7
3. Expenses:
• All expenses incurred for a particular contract should be charged
to that contract
4. Plant and Machinery:

• The depreciation on the P&M used to complete a contract is charged

to the contract account as per the policy of the firm on charging
depreciation
5. Sub-contract:

• Sometimes due to certain situations, a sub-contractor is appointed

to carry out certain special work for the main contract.
• This special work done by the sub-contractor becomes a direct
charge to the main contract and accordingly debited to the contract
account.
• Eg: The job of fitting electrical lines in a Building construction
21
contract may be sub-contracted to a specialist in8 Electrical cabling/
 Cost Plus Contract

 When it is not possible to estimate the cost of a contract in

advance for various reasons, we use the cost plus contract system
to determine the cost in advance.
 This system is used when the costs fluctuate over the contract
period as contract work takes longer time to complete
 This system may also be used when a contract is totally new
and cost estimation cannot be done with accuracy
 In this contract, the contractor will receive a certain percentage of
total cost as profit.
 This system of costing is applicable and more suitable to special
type of work contracts such as construction of shipyards, dams, etc

21
9
 Advantages and Disadvantages of Cost Plus Contract

1. The contractor has no risk of loss. But the customer has to pay more
if the cost escalates, maybe on account of inefficiency.
2. The contractor is protected from the increased cost of inputs.
However, the customer is not certain about the price of the contract
till the end.
3. If the price of inputs remains favourable, the contractor does not
get benefit. The benefit goes to the customer.
4. It is a simplified way to prepare tenders for contractors

22
0
 Work Certified

• It is known that construction works usually take a longer period of

time for work completion.
• The customer needs to make payment from time to time
depending on the extent of work already completed.
• This amount is paid on the basis of a certificate issued by an
architect or the chartered engineer.
• This is called Work Certified
• This also helps to monitor the work progress from time to time
and also estimate and monitor the cost

22
1
 Quiz

Q1 . All of the following would most likely use a job order costing
system except:
a. A dental practice
b. Auto repair shop
c. Appliance maker of small size
d. Architectural Firm

Answer: Appliance maker of small size

22
2
 Quiz

Q2 . The Chartered Institute of Management Accountants (CIMA),UK

defines Contract costing as “ the aggregate costs relative to a
single contract designated as…“
a. Cost Unit
b. Performance measurement
c. Variable Overhead

d.Contract Cost

Answer: Cost

Unit

22
3
 Key Words

 Job costing: This costing technique is for a particular job.

 Batch costing: The assessment of cost for a particular batch of
production.
 Contract costing: The cost allocation methodology of a contract work
 Economic batch quantity: The optimal size of a batch from costing
point of view.
 Set - up cost: The cost involved in changing one set-up of
production process to another set-up.
 Sub-contract: A part of the contract work is given to another
contractor by the main contractor.
 Cost plus contract: When a contract is tendered based on certain
profit margin over the cost

22
4
 Let Us Sum Up

Job Costing: A Job is a customer specific order . Work of each unit/

process on a particular job is identifiable and the cost associated
with it can also be measured.
Batch Costing: Production of multiple quantities of similar products at
one time is known as Batch production. Batch costing is applied
when certain quantities of similar and identical products are
manufactured as one job.
Contract Costing: Contract is like a job but larger in value and duration.
For eg: Ship building, construction of a building etc. In contract
costing, most of the costs associated with that particular contract
can be identified and directly allocated to the same. Contract
Costing is used to measure the cost and profit of a particular contract
assignment Eg : Civil engineering work in a construction project.

32
 Cost and Management Accounting
Session 7

Income Recognition under Marginal and

Absorption
costing Process Costing and Joint costing
 Marginal Costing

Marginal cost can be explained as a change in the total cost of productio

one additional unit of output.
Alternatively, per unit change in the cost of increased output is marginal c
Sales = Fixed Cost + Variable Cost + Profit
Contribution = Sales Revenue – Variable Cost
Contribution = Fixed Cost + Profit
Profit = Contribution – Fixed Cost
 Marginal Costing

Marginal cost can be explained as a change in the total cost of

production of one additional unit of output. Alternatively, per unit
change in the cost of increased output is marginal cost

• Opening stock = Sales + Closing stock – Production

• Closing Stock = Opening stock + Production – Sales
• Production = Sales – Opening Stock + Closing Stock
• Sales = Opening Stock + Production – Closing Stock
 Features of Marginal Costing

1. Cost classification: All costs are classified on the basis of variability

is, variable costs and fixed costs. Mixed costs are segregated into va
and fixed costs.
2. Inventory valuation: Under marginal costing, inventory or stoc
valued at variable cost or marginal cost for profit measurement.
3. Product and period costs: Under marginal costing, all variable
are treated as product cost and fixed costs are treated as period c
product cost is charged directly to cost unit, whereas a period c
written-off against the profit of the period.
 4.Contribution: Marginal costing technique makes use of
contribution for making various decisions. Contribution is the
difference between sales and variable cost. It is on the basis of the
contribution of a product that production and sales policies are
designed by a firm.
5.Determination of Price: The price is determined on the
basis of the marginal cost and contribution margin.
6. Department/Product Profitability: The contribution margin is the
basis for
deciding profitability of department or product.
7.Treatment of fixed costs: Fixed costs are treated as period cost
and debited to profit and loss account and, thus, excluded from the
production cost
 Break Even Point

The Break Even point (BEP) is that quantity of output sold at which
total
revenues equal total costs
i.e the quantity of output sold that results in Rs 0 of operating income.
At the BEP, operating income by definition is 0 and hence:
Break even number of units = Fixed Cost .
Contribution per unit
Break Even Point
 Break Even Point (Example)
Kinder Kids provides day care for children Mondays through Fridays.
The
monthly variable costs per child are as follows:
Lunch and snacks Amt (Rs.)
1,000
Educational supplies 300
Other supplies 200
Total 1,500
Monthly fixed costs consists of the
following:
Rent Amt (Rs.)
15,000
Salaries 20,000
Utilities 2,000
Miscellaneous 3,000
Total 40,000
Kinder Kids charges each parent Rs 4000/- per child Calculate the
BEP
 Break Even Point (Example)
Kinder Kids provides day care for children Mondays through Fridays.
The
monthly variable costs per child are as follows:
Solutio Amt
n: (Rs.)
Revenue per child 4000
Less: Variable cost per child 1500
Contribution Margin per child 2500

BEP Fixed cost

= .
Contribution per
child / 2500 = 16
= 40,000
children
 Limitations of Marginal Costing

1. Segregation of Fixed cost and Variable cost: At times,

it becomes
difficult to segregate the fixed cost and the variable cost.
2. Per unit Variable cost vs Activity levels: Marginal costing
presumes that per unit variable cost will remain the same
at all levels of activity, which is not true.
3. Not an accepted accounting practice: Marginal costing
concept is not an accepted accounting procedure for external
reporting. It is used primarily used for Internal reporting and
decision making
 Advantages of Marginal Costing

1. Marginal costing is simple to understand.

2. By not charging fixed overhead to the cost of production, the
effect of varying charges per unit is avoided.
3. It prevents the illogical carry-forward in stock valuation of
some proportion of current year’s fixed overhead.
4. The effects of alternative sales or production policies can be made
readily available and assessed and decisions taken would yield
the maximum returns to the business.
5. It eliminates large balances left in the overhead control accounts,
which indicates the difficulty of ascertaining an accurate overhead
recovery rate.
6. Practical cost control is greatly facilitated. By avoiding arbitrary
allocation of fixed overhead, efforts can be concentrated on
maintaining a uniform and consistent marginal cost. It is useful at
various levels of management
 Advantages of Marginal Costing… Cont.

7.It helps in short-term profit planning by break-even and

profitability analysis, both in terms of quantity and in terms of
graphs. Comparative profitability and performance between two or
more products and divisions can easily be assessed and brought to
the notice of the management for decision making.
8. It helps in cost–volume–profit analysis.
9. It is also helpful in budgeting and production planning forecasting.
10.Profit and loss account is not affected by the level of closing
inventory.
11.The performance evaluation becomes more effective in
case of responsibility accounting system
 Absorption Costing

Advantages of Absorption Costing

1. It is a recognized and accepted accounting practice for external
reporting.
2. It uses the accrual accounting concept of matching costs with
revenue for a
particular time period.
3. Fixed cost is absorbed in the production cost and the inventory
valuation complies with accounting standards.
5.
4. The fixed
There is a production
proper overheads
adjustment areover
of under or also
absorption to
of fixed
allocated
costs. units/divisions. different

6. It is better for the firms which follow cost plus pricing

method
 Limitations of Absorption Costing

1. The advocates of marginal costing are of the view that carrying

over the fixed cost component of the existing year, which has
been debited to profit and loss account to the next year, is not
appropriate.
2. The profit and loss account will be affected to the extent of
value of closing inventory.
3. It is not helpful in taking managerial decisions where
management wants to know the incremental cost on account of
increased output.

1
6
 Difference Between Marginal Costing and Absorption
Costing
Compone Marginal Costing Absorption Costing
nt/ Basis
Separation of Costs are separated Costs are separated
costs into variable costs into those that can
and fixed costs be traced to cost
centre or cost units
and those which
cannot be traced
Product Costs Variable costs are Both Fixed and
product costs and Variable costs
fixed costs are are product
period costs costs
Stock Valuation Only variable costs Both Fixed and
are included in stock Variable costs
valuation whereas are included in
fixed costs are stock valuation
charged to income
statement
 Difference Between Marginal Costing and Absorption
Costing
Compone Marginal Costing Absorption Costing
nt/ Basis
Profit Computed as Computed as gross
Contribution profit
and net profit and net profit
Decision Making Suitable and more Unsuitable for
meaningful for decision
Management making
decision making. Eg
: Make or Buy
decisions
Recovery Only those costs All manufacturing
of Costs that can be traced costs are
to the products recovered
 Analysis of Difference in Income

1. When quantity of sale is lesser than production which results in higher

inventory level (closing stock is more than opening stock). In this situation,
the income will be on the higher side under absorption costing method
as the part of fixed overheads are carried forward to the next period.
Income under marginal costing will be lesser as compared to absorption
costing.

2. When quantity of sale is higher than the quantity produced. This will
result in lower level of closing inventory (opening stock is more than
closing stock). The income will be on higher side under the marginal
costing system as more fixed overheads are adjusted in the current period
in absorption costing. Or we can say that a part of the fixed cost of the
previous period has been adjusted to current period cost of goods sold.

3. If quantity sold is equal to quantity produced, there is no closing inventory.

Income under both the approaches will be the same.
Analysis of Profit under marginal and absorption costing

Production Level Profit under Profit under

Marginal Absorption
Costing Costing
Production = Sales Equal Equal
Production greater Lower Higher
than Sales
Production less than Higher Lower
Sales
Format of Income Statement under Marginal Costing
Format of Income Statement under Absorption Costing
Problems and Solutions
Contribution = SP – VC = Rs. 24000 – 10000 – 3000 = Rs.
11000
Absorption
Costing

70,00,000/5
00
units =
14000
60,00,000/4
00
units =
15000
 Reconciliation of Variable Costing and Absorption Costing

 Under absorption costing, fixed overhead appears in the cost of

goods
sold and also in the production volume variance.
 Under variable costing, fixed overhead is a period cost
 Key Words

1. Marginal Cost:Change in the total cost on account of change in

one additional unit of production
2. Marginal Costing: A concept of recognising
income based onvariable
production cost
3. Absorption costing: An approach which considers both fixed and
variable costs while considering production cost
4. Contribution: Sales Revenue – Variable Cost
5. Profit: Contribution – Total Fixed Cost
6. Fixed Overhead absorption rate: Total Fixed cost / Normal
capacity of production
 Let’s Sum Up

Marginal Costing: It is defined as the technique of

presenting cost data wherein variable costs are fixed costs
are shown separately for Managerial decision making.
Only variable costs are charged to cost units (product or
inventory) whereas fixed cost for the period is written off
against the profit of the period.
Hence, Marginal costing is also known as Variable
Costing Technique
 Let’s Sum Up

Absorption Costing:
It is a costing technique in which all manufacturing costs (variable and
fixed) are considered as costs of production.
Fixed overhead is treated as a period cost and not a product cost.
All variable manufacturing costs and fixed production overheads
for manufacturing are charged to the product.
Other costs such as Admin and S&D overheads are written off
against the
profit of the period in which they arise.
Therefore full cost of a product or stocks comprises the variable
(direct) and fixed (indirect) cost of production.
Hence Absorption costing is also known as full costing.

3
1
 Quiz Time

Q1 Marginal cost is taken as equal to:

a. Prime cost plus all variable overheads
b. Prime cost minus all variable overheads
c. Prime cost plus Variable overheads plus Fixed
overheads
d. None of the above

Answer: a. Prime cost plus all variable overheads

 Quiz Time

Q2. Which of the following statements are true ?

a. In Absorption Costing, cost is divided into 3 major parts while in
Marginal costing, it is divided in 2 main parts
b. In Absorption Costing, period is important and in Marginal
costing,
product is important
c. Both a and b
d. None of the above

Answer: c. Both a and b

Process costing
 Process costing
Process Costing is a method under which the cost is ascertained
process wise. This is a method of costing under which costs are
accumulated for each process separately.
Essential features of process costing are:
1. The work process is segregated into different processes and each
process becomes the cost center responsible for maintaining the
cost within the pre-determined standards.
2. The final product is the result of continuous series of processes.
3. All the processes are pre-arranged and specific to give a certain
shape to
the product.
4. The firm is required to maintain separate account for each process
and all the related costs, direct and indirect are allocated to that
process.
5. The treatment of wastage, abnormal loss/gain, scrap value etc are
accounted in the concerned process.
 Process costing

6. The semi finished output of one process becomes the input for
the next
process in sequence.
7.During the process, different products may be produced at one
or multi- stages simultaneously.
8.While output of one process is transferred to the next process,
the cost of the process is also transferred. Thus, output cost of one
process becomes the input cost of the next process.
9. The adjustments of normal loss, abnormal loss and abnormal gain
are done
under different processes depending on the nature of loss or gain.
10.As the work continues under each process, there is always
work-in- progress (WIP) at the end of the process which is carried
over to the next process. The costing is done on the basis of
equalization concept.
 Application of Process Costing

Process costing method is adopted in the following types of

Industries:

• Soap making
• Oil refining
• Biscuit manufacturing
• Milk Dairies
• Textile Mills
 Difference between Process and Job costing

Component Job Costing Process Costing

s/
Basis
Production Each job has separate Production is in
process for cost determination continuous flow and
specific homogenous
jobs
Entity Each job is separate and Costs are complied for each
independent of others process and cumulative for
production in a given
period of time
Per unit costs The cost of a job is divided There is no product
by the number of units in manufactured on a
the job to arrive at the unit continuous flow
cost
Measuremen Costs are measured when a All individual entity costs of
t of cost job is completed each process are divided by
the total production for the
process to calculate cost per
unit
 Difference between Process and Job costing

Componen Job Costing Process Costing

ts/ Basis
Cost transfer Cost is not transferred from Costs are arrived at the end
one of
job to another cost period
Work-in- There may or may not be Costs are transferred from
progress WIP at the beginning or one process to another as
end of the accounting the product passes from
period. one process to another
Control Adequate control on cost is There has to be some WIP
difficult, as each product at the beginning as well as
unit is different and the the end of the accounting
production is not continuous period as the process is
ongoing
Focus It is customer-specific Adequate control is possible,
as the production is
standardized and it is stable
also
 Similarities between Process and Job costing

1. The goal of job and process costing systems is the same,

that is to
determine the cost of products.
2. The cost flows under both the costing systems are also similar.
There are separate records in production account for raw
materials inventory, labor and overhead. Thereafter, the costs
are transferred to a work-in- process inventory account.
3. In both the cases overhead rates are pre-determined for
absorption of
overhead expenditures.
Process costing – Flow of Cost
Process costing – Flow of Cost
 Treatment of Normal, Abnormal Loss and Abnormal Gain

Normal loss: Cost of normal process loss in practice is absorbed by

good units produced under the process. The amount realised by the sale
of normal process loss should be credited to the process account.

(Normal loss units are credited, and sale value is credited to Process
account) It will reduce the number of units transferred to next Process.
Abnormal Process Loss: Loss in excess of the pre-determined loss
(normal loss).
The cost of abnormal loss is not treated as part of the cost of the
product. The
total cost of abnormal process loss is debited to costing profit
and loss account.
Abnormal Process Gain: When the anticipated normal loss is low. It is
debited with the abnormal gain and transferred to costing p/l a/c.
Joint Products and By Products
 Joint Products and By Products

Joint Products: Two or more products separated in the course of

the same processing operation usually requiring further processing,
each product being in such proportion that no single product can
be designated as a major product. Eg: gasoline, diesel, kerosene
obtained from crude oil
By-Products: Products recovered from material discarded in a main
process or from the production of some major products, where the
material value is to be considered at the time of severance from the
main product. Eg: Molasses in manufacturing of sugar

Joint products occurs in many industries such as petroleum, oil

refinery, textiles, dairy, food processing and many other process
industries.
 Difference between Joint Product and By Product

The main points of distinction as apparent from the definition of Joint

Products and By-Products are:
a) Joint products are of equal importance whereas by products are of
small economic value
b) Joint products are produced simultaneously but the by-products
are produced incidentally in addition to the main products.
 Joint Costs

• The common costs associated with the combined process of productio

called joint costs.
• The common costs are incurred up to the split-off point. A point where
joint products are split off into individual products is called split-off poin
• The common costs need to be allocated to individual products to have
assessment of the cost to an individual product.
• Allocating the joint costs to individual products is an issue. There is
uniform policy and individual firms adopt policy convenient to them
 Methods of Costing of Joint Products

Issue: To allocate the joint costs. It impacts the valuation of closing

inventory,
pricing of products and to find the profit or loss on sale of different
products.
Methods used:
1. Average Cost Method: Total process cost (upto the point of
separation) is divided by total units of joint products produced. On
division averge cost per unit of production is obtained.
2. Physical Quantity Method: Costs are apportioned on the basis of
physical
quantity – weight, numbers
3. Survey Method: Based on market survey of factors such as
quantity, selling price, technical aspects etc. Not a very rational
method as subject to bias.
4. Sales Revenue Method: Joint costs are allocated in the proportion
of sales revenue.
 Quiz

Q1 If a firm obtains two saleable products from the refining of one ore,
refining process should be accounted for as:
a. Mixed process
b. Joint process
c. Extractive Process
d. Reduction process

Answer: b. Joint process

 Quiz

Q2 Joint cost allocation is useful

for:
a. Decision making
b. Product costing
c. Cost control
d. Performance evaluation

Answer: b. Product
costing
 Quiz

Q3 Joint costs are most frequently allocated based upon

relative
a. Conversion cost
b. Profitability
c. Sales value
d. Prime cost

Answer: c. sales
value
 Quiz

Q4 The very objective of process costing system

is to:
a. Summarize flow of output
b. Compute output in units
c. Arrive at total costs
d. Calculate cost for each equivalent unit

Answer: a. summarize flow of

output
 Quiz

Q5 A method to calculate per equivalent unit cost of all

production
related work completed is known as:
a. Weighted average method
b. Net present value method
c. Gross production method
d. None of the above

Answer: a. Weighted average method

 Cost and Management Accounting
Session 8

Chapter No 8 Standard Costing and Variance Analysis

 Standard Costing

Nature
of
Variance
s
Comparison Variance
Determinatio
of Actual n
s of Causes
Determination Costs and of
of Actual Standard
Establishing Costs Cost
Standards

27
8
 Standard Costing and Variances.. An introduction:

 Every Organization, regardless of it profitability or growth, has to

step back and take a hard look at its spending decisions
 And when customers are affected by a recession, the need for
managers to use Budgeting and variance analysis tools for cost
control becomes especially critical
 By studying variances, managers can focus on where
specific performances have fallen short and use the information
they learn to make corrective adjustments and achieve
significant savings for their companies
 Management by exception is a practice whereby Managers focus
more closely on areas that are not operating as expected and
less closely on areas that are

27
9
 Objectives of Standard Costing

1. To exercise control on costs by determining standards in advance.

2. To set standards for quantity and price of various components of
cost, such as raw materials, labour and overheads. The standard so
fixed becomes a goal for future to be achieved.
3. To compare standard costing of one firm with other firms in the
industry.
4. To monitor and control the costs by comparing standard costs with
actual costs.
5. To fix the responsibility of the concerned department based on
variance analysis.
6. To take suitable measures to reduce cost and bring efficiency
under different cost components.
7. Once the standards of cost for various cost components are fixed,
the cost control authority is given the responsibility for monitoring
and control of costs at different levels. Thus, control system
becomes easy through standard costing
28
0
 Factors
Determining
Standards Under
each Cost
Component

Direct raw
Direct labour cost Overhead cost
material
cost

28
1
 Uses of Standard Costing

1. Processing units where the process of output and the nature of

product are the same, such as chemical engineering, paper
making and metal processing.
2. In all those works where methods of manufacturing process are
repetitive and products are homogeneous, such as food products and
electricity.
3. In service units where operating costing system is implemented,
such as transport and gas
4. In industries where varieties of products are manufactured, such as
textile and engineering works
5. Industries where extraction work is done, such as coal, oil and timber
6. All other manufacturing and services units where unit cost
component is prevailing
7. In construction work, contract work, ship building and erection work
28
2
 Benefits of Standard Costing

1. Variance Analysis: It helps in variance analysis. The actual

cost is compared with the standard cost and variance is found.
This is required to initiate corrective actions and facilitates
effective cost monitoring and control and helps cost reduction.
2. Management Decision making: Standard costing helps in
determination of selling prices, production planning, valuation
of inventories and transfer of output from one process to
another. It is an effective tool for management for taking various
business decisions.
3. Overall Management: Once the system of standard costing
becomes efficient and operational, the management can focus
on other policies and development issues

28
3
 Benefits of Standard Costing …

4. Determining Responsibility: Standard costing also helps in

fixing responsibility of the manager responsible for variations in
costing. Once the managers have a sense of responsibility, they
become more cautious towards monitoring the required standards.
5. Cost Consciousness: It creates a sense of cost consciousness of
all the concerned because of responsibility and variance
analysis. The responsibility is assessed in both ways, that
is, for favourable or unfavourable performances and reward/
adversely impact performance of the concerned accordingly.
6. Budget Preparation: Standard costing also helps in preparing
fairly accurate and meaningful budget for the future: short-term or
long-term. Based on available data on all the costing aspects, more
accurate budget can be proposed

28
4
 Benefits of Standard Costing …

7. Economies: Standard costing brings economies in terms of

effective utilization of resources, such as manpower, machines
and materials. This results in increased productivity and
efficiency in cost management.
8. M I S Preparation: Standard costing also facilitates preparation
of financial reports for analysis and other uses. Thus, the
management gets an indication of trends of business activity and
also the likely future trends.
9. Flexible Budgets: It also helps in preparation of flexible budget
more conveniently and easily due to standard costing

28
5
 Limitations of Standard Costing

1. Fixing Standards: Determination of standard for various cost

components requires high degree of technical skills and fair
knowledge. Therefore, small units may find it difficult to establish
standard costing system in view of limited financial resources.
2. Fixing Responsibility: Practically, fixing up of responsibility in case of
wide gaps in variance analysis becomes difficult as there are many
internal and external factors for such variations. Some are
controllable where others are not.
3. Arbitrary process: Fixing standards is an arbitrary process. It may
be either too stiff or too liberal. Different firms may have different
approaches as convenient to them.
4. Not a dynamic approach: It is only a cost control tool. There is a
limited scope for dynamic approach.

28
6
 Standard Costing Vs Budgetary Control

Components / Basis Standard Costing Budgetary Control

Cost Component Costs components Components included
involved in in Budgetary control
production process are related to income
alone are included and expenditure. It is
based on budget of a
firm
Applicability Standard Costing is Different types of
related to budgets are prepared
production process for all the business
alone operations of the firm.
It caters to huge
activities
Cost Vs Cost of a product Total expenditure and
Total is shown per unit per unit cost of a
Expenditure in Standard product are both shown
Costing in a budget
28
7
 Standard Costing Vs Budgetary Control …

Components / Basis Standard Costing Budgetary Control

Individual activity Based on total Separate Budget is
vs Total production units in prepared for each
production a short period activity
Inter – dependence Functions only There need not be any
with Budgetary standard costing
control system system for budgetary
control
Variance Analysis Variance analysis is There is no variance
an important aspect analysis in budgetary
of Standard costing. control. It is carried
It is done for all the out only if actual
cases irrespective of expenses are more
favourable and than the budgeted
unfavourable results expenses

28
8
 Standard Costing and Variance Analysis

The variance can be explained as a gap (deviation) between actual

cost and standard cost.
The variances may be analysed with respect to
various elements of costs, sales and profit.
1. Material cost variances
2. Labour cost variances
3. Overhead variances
4. Sales variances
5. Profit variances

28
9
 Standard Costing and Variance Analysis

The variances in actual and standard costs can happen on account

of following:
1. Variance on account of functions, such as cost function, profit
function and sales function.
2. Variance in relative terms, for example, difference between
actual and standard cost in unit terms or percentage terms. It can
be absolute term when difference in standard cost and actual cost
is measured in money terms.
3. Variance can be favourable or unfavourable as explained earlier.
4. Variance may be controllable when the decision of management can
affect the cost control. It can also be non-controllable variance if
it cannot be controlled due to external factors.

16
 Standard Costing and Variance Analysis

We will consider the example of Color Plus company, a firm

that manufactures an sells jackets to understand the variances
throughout the topic.
The jackets manufactured by Color Plus require tailoring and many
hand operations. Color plus swells exclusively to distributors who in
turn sell to independent clothing stores and retail chains.
For simplicity, we assume the following:
1. Color Plus’s only costs are in the manufacturing division. No costs
incurred in other value chain functions such as Marketing and
Distribution etc
2. All units manufactured in the month of Jan 202X are sold in Jan 202X.
3. There is no Direct Materials inventory at the beginning or end of
the period.
4. No work in process or Finished goods inventory at the beginning or
end of the period
29
1
 Standard Costing and Variance Analysis

The budgeted variable cost per jacket for each

category is:
Cost Category Variable Budgeted Rs. 27,60,000/-
Cost per fixed cost for
Jacket production
(Rs.) between 0 to
12000 jackets
Direct Material 600
Direct Labour 160 Budgeted Rs. 1200
Selling per jacket
Variable Mfg OH 120 Price
Total Variable Cost 880 Budgeted 12000 jackets
Production
The number of units manufactured and Sales
is the cost driver for Direct
Materials, direct manufacturing Actual 10000 jackets
Production
labour and variable
and Sales
manufacturing overhead. The
relevant range for the cost
driver is from 0 to 12000 jackets 29
2
Particulars Actual Budgeted Variance Remarks
Units Sold 10000 12000 2000
Revenue 1,25,00,000 1,44,00,000 19,00,000 Unfavourable
Variable Cost
Direct Material 62,16,000 72,00,000 9,84,000 Favourable
Direct Wages 19,80,000 19,20,000 60,000 Unfavourable
Variable Mfg OH 13,05,000 14,40,000 1,35,000 Favourable
Total Variable Cost 95,01,000 1,05,60,000 10,59,000 Favourable
Contribution Margin 29,99,000 38,40,000 8,41,000 Unfavourable
Fixed Cost 28,50,000 27,60,000 90,000 Unfavourable
Operating Income 1,49,000 10,80,000 9,31,000 Unfavourable

29
3
 Material Cost Variances

Material
Cost
Variance

Material Material
Price Usage
Variance Variance

Material Mix Material Yield

Variance Variance

29
4
 Material Price Variance

Material price variance = Actual Quantity used* (Standard Price - Actual price)

Material price variance may happen on account of any of the

following reasons:
1. Variations in the market price than the standard price
2. Change in quantity actually purchased in comparison to standard
quantity required
3. Purchase of non-standard materials as per the need
4. Higher or lesser carrying cost than the budgeted one
5. Inefficient/Efficient purchase policy of the firm
6. Difference in actual purchase discounts than expected
7. Other external reasons, such as inflation and scarcity of raw
materials

29
5
 Material Usage (Quantity) Variance

Material usage variance = Standard Price* (Standard qty - Actual qty)

Material usage variance may happen on account of any of the following
reasons:
1. Higher or lower wastage on account of leakages, evaporation, etc., in
storage as compared to expected quantity losses.
2. Difference in the quality of materials actually purchased as
compared to planned quality of materials. It may be either superior
quality or inferior quality.
3. Higher or lesser wastage on account of scrap, normal wastage,
spoilage, etc., than the standard quantity of wastage
4. Improper upkeep of materials resulting pilferage of materials.
5. Theft and leakages of materials due to improper security
arrangements at the storage
6. The standards set might not be correct
7. Technological reasons resulting in higher or lesser consumption of
materials.
29
8. Inefficient handling of materials in the production
6 process
 Example

The following information is available in respect of a product for January

202X
Budgeted production 200 units
Standard consumption of raw materials 2 kg per unit
Standard price of material Rs. 6 per kg

Actually 250 units were produced and the material was purchased
at Rs.
8 per kg and consumed at 1.8 kg per unit. Considering the
cost information, we need to compute relevant material cost
variances.

29
7
 Solution

Actual Production 250 units

Standard quantity for actual production 2 x 250 = 500 kg (SQ)
Actual quantity for actual production 1.8 x 250 = 450 kg (AQ)
Standard price / kg Rs. 6 (SP)
Actual price / kg Rs. 8
Material cost = (SP x SQ) – (AP x
variance AQ)
= (6 x 500) – (8 x
Material price 450)
variance ==(63000
– 8) x– 450
3600==900
600(A)
(A) (SQ – AQ) x
Material Usage variance=
SP = (SP – AP) x AQ
= (500 – 450) x 6 = 300 (F)

Material cost variance = Material price variance + Material usage

variance 600 (A) = 900 (A) + 300 (F)
29
8
 Material Mix Variance

Material Mix Variance = ( Standard Cost of Actual Mix at Standard rate of

Mix) – ( Actual cost of actual Mixture)

= Standard Price * {Actual Quantity in standard mix (known as RSQ) –

Actual Quantity}
RSQ = Total Actual Qty consumed x Standard porting of particular raw
material Total Standard Mix for all the materials

Material Sub-usage Variance = (Std Qty – Revised Std Qty) x Standard

Price

29
9
 Material Yield Variance

Material Yield Variance = Standard cost of material per unit of output*

(Standard Output for actual inputs of raw material – Actual output

Standard cost of material = Total cost of actual output at Standard

price
per unit of output Standard output for actual inputs

30
0
 Labour Cost Variance

Labour
Cost
Variance

Labour Labour
Rate Efficienc
Variance y
Variance

Labour Labour idle Labour

mix time Yield
variance variance Variance
LCV = LRV + LEV
LEF = LMV + LITV + LYV

30
1
 Labour Rate Variance

Labour rate variance = Actual Labour time worked* (Standard wage rate)

Labour rate variance may occur on account of following reasons:

1. Change in labour mix than the pre-determined standards, may be
on account of shortage of labour in a particular category, labour
sitting idle for want of materials and other equipment.
2. Rise in wage rates due to inflation or wage rate policy of the
government such as minimum wages act.
3. Hike in wage rate due to overtime work where the wage rate is
higher or
working in night shifts. In both the cases, the actual wage rate
will be higher than the standard.
4. Improper allocation of job among the workers.
5. Policy changes in the incentive schemes to be provided to the
employees.
6. Increased idle labour time due to external factors, such as power
failure and machine breakdown
30
2
 Labour Efficiency Variance

Labour efficiency= Standard Wage rate × (Std labour

hours–Actual labour Variance hours)
The labour efficiency variance may arise on account of the following
reasons:
1. More wastage of time due to lack of proper monitoring and
supervision
2. Inefficiency of labour productivity may be on account of adverse
working conditions
3. Higher number of labour turnover
4. Power failure or any other unexpected event such as machine
breakdown
5. Frequent interruptions in the production process
6. Lack of trained and skilled workforce
30
7. Ineffective co-ordination among different units3
 Idle Time Variance
The idle time can be defined in terms of non-productive time spent by
workers
i.e. time remaining idle without doing work.
Standard Idle Time:
• There are standard norms for idle time as a firm needs to give
some time for lunch breaks, refreshment breaks (incl. restroom
breaks), etc.
• This is known as standard idle time which is included in the
production process itself
Abnormal Idle Time:
• However, there maybe occasions where workers spend more time
without work (greater than standard time), this is known as
‘Abnormal Idle Time’
• This may happen for 2 reasons:
• Either a deliberate attempt to waste time by workers
30
• Or dueto external factors on account of power failure,
It is the Abnormal Idle Time that needs to be calculated for variance
purpose.
This variance is always unfavorable, calculated as follows:
Idle Time variance = Abnormal Idle time * Total Man hours *Standard
wage
rate per hour

30
5
 Labour Yield Variance

 This happens on account of difference in standard yield in given

number of work hours and actual yield obtained in actual work hours
 Eg: a product requires two hours to produce and in a particular
process, workers worked for 1200 hrs. As per the standards, the
output in given number of hours would have been 600 units.
However, the actual output may differ.
 It may be either higher or lower than the required standard
 This difference between actual and standard causes variance,
which maybe favorable or unfavorable.
 The variance is calculated as follows:
Labor Yield Variance = (Standard yield in units expectedfrom the
actual hours worked less Actual yield) * Standard labour cost per unit

30
6
 Labour Mix Variance

 The different composition of workers comprising skilled,

semiskilled and unskilled, men and women, is known as labor mix.
 The firm may have pre-determined standards of labor mix among
various groups. However, the actual mix may differ at the time of
production
 This causes variation due to change in composition of workers as
the wage rate for different groups are different and therefore impact
the costs
 The changes in worker composition may occur on account of:
 Non availability of required number of workers in a
particular category OR
 Change in firm’s policy to change the compositionin view
of cost considerations.

30
7
 Labour Mix Variance

Labour Mix Variance = (Revised Standard hours-Actual hours)* Standard

rate per hour
The revised standard hours can be calculated as follows:
Revised Standard Hours = Standard Hours for the particular
composition / Total Standard Hours * Total Actual hours

30
8
 Problems and Solutions
The following information is available about a product for the month
of December 2022:
Particulars Units
Material Purchased 24,000 kg (Rs.105,600/-)
Material Consumed 22,800 kg
Actual wages paid for 5940 Rs. 29,700/-
hours
Units produced 2160
Standard Rates and prices are as follows
Direct material rate Rs.4 per unit
Direct labour rate Rs. 4 per hour
Standard input 10 kg for one unit
Standard labour hour per unit 2.50 hours per unit

Based on the data and information, calculate relevant Material and

Labour cost variances
30
9
 Solution

Material Variances
Material Cost Variance
= (SQ*SP) - (AQ*AP) = (2160*4*10) - (22800*4.4) =Rs 86,400 - Rs
100,320 = Rs 13,920 A
Material Price Variance = AQ(SP-AP) =22,800kg ( 4 - 4.40) =Rs 9,120 A
Material Usage Variance = SP(SQ-AQ) =4 (21,600-22,800) = 4800 = Rs
4,800 A

Standard Quantity (SQ)

21,600 Standard Price (SP)
per unit 4.0 Actual Quantity
(AQ) 22,800
Actual Price (AP) per unit
105,600/24000 = 4.4 31
0
 Solution

Labour Variances
Labour Cost variance = (SH*SR)- (AH*AR) = (2160*2.50*4) -
(29700)
= 21600-29700 = Rs 8,100 A
Labour Rate variance = AH (SR-AR) =5940 (4 - 5) = Rs 5,940 A
Labour Efficiency variance = SR ( SH-AH) =4 ( 5400-5940) =Rs
2,160 A

No of Units produced 2160 units

Standard Hours (SH) per unit 2.50 hours per
unit Total Standard Hours (SH) =2160*2.5 =
5400 hours Standard Rate (SR) Rs 4/- per hour
Actual Hours (AH) 5940 hours
Actual Rate (AR) 29,700/5940 = Rs 5/- per
hour AH*AR ( given) 29,700/
31
1
 Overhead Cost Variances

Total
overhead
variance

Variable Fixed
overhea overhead
d variance
variance
Expenditur Volume
e variance
variance

Labour Labour idle Labour

mix time Yield
variance variance Variance
31
2
 Variable Overhead Variance

Overhead Variance = AO ( SR-AR)

= (AO*SR) - (AO*AR)
= SVO – AVO
Where
• AO = actual output
• SR = standard rate
• AR = actual rate
• SVO = standard variable overhead and
• AVO = actual variable overhead
Variable Overhead Variance = (Standard Hours x Standard variable overhead
rate per hour) - (Actual Hours x Actual Variable overhead rate per hour

31
3
Variable Overhead Spending (Expenditure) Variance

This will vary with direct labour hours of input that is budgeted and
actual labour hours.
The actual variable overhead spending may be different from the
budgeted variable OH spending.
This will cause favourable or unfavourable variance which can be
calculated as follows:
Variable overhead spending Variance = (Actual Hours x Standard Variable
Overhead rate per hour) – (Actual Hours x Actual variable overhead rate
per hour

31
4
 Variable Overhead Efficiency Variance (VOEV)

Efficiency variance measures the efficiency of labour hours working

with the standard output.
Therefore the variation between the actual hours used to complete
the work and the standard hours required to complete the work may
vary.
This indicates efficiency which can be measured in terms of cost
savings or excess cost incurred and calculated as follows:

Variable overhead efficiency variance = (Standard hours allowed for actual

output – Actual hours used for actual output) x (standard variable overhead
rate per hour
= (Actual output hours x Standard per unit) – (Actual hours x Standard
variable overhead recovery rate)

31
5
 Fixed Overhead Variance

Fixed OH variance is caused due to over absorption or under

absorption of fixed overheads.
Fixed OH are not affected by the volume of output as it remains the
same irrespective of output.
Fixed OH variance occurs o/a difference between standard fixed OH
and actual fixed OH on actual output
Fixed Overhead Variance = TS C – TAC
Where, TSC = total standard cost for actual
output, TAC = total actual cost
Fixed Overhead Variance = TSO-TAO
Where
TSO = total standard overhead
and
TAO = total actual overhead.
Fixed Overhead Variance = (AO*SFO)- (AO*AFO)
Where,
AO = actual output,
SFO = standard fixed
overhead, AFO = actual fixed
31
overhead 6
 Fixed Overhead Variance

The fixed overhead variance may be further sub-divided into

expenditure variance and volume variance.
1. Expenditure or spending variance:
• These are fixed OH charged as an expense for a specific time period.
• These remain unchanged during a short span of time
• Fixed OH expenditure variance explains the difference
between the amount actually spent during a certain period as
fixed overhead and the amount of fixed OH budgeted for the period.
• It is calculated as follows:

Expenditure Variance = Budgeted Fixed Overhead – Actual Fixed Overhead

31
7
 Fixed Overhead Variance

2. Volume Variance
• Volume relates to measurement of output
• This variance maybe caused mainly due to the difference between
budgeted output and actual output
• This variance indicates the over absorbed OH or under absorbed
OH on account of the difference in budgeted level of output and
actual level of output
• The volume variance may occur on account of labour
efficiency or inefficiency resulting in higher or lower output than
budgeted. Also, the number of hours available for working maybe
lesser or higher than the planned hours in the budget

31
8
 Fixed Overhead Variance

2. Volume Variance:
 To arrive at this variance we find out the difference between
budgeted output and actual output and then multiply it by the
standard fixed OH absorption rate
 Volume Variance = SC (AQ - BQ)
 Where,
• SC= standard cost per unit of fixed OH
• AQ= actual output in actual hours worked
• BQ= budgeted standard output planned in budgeted standard hours

31
9
 Fixed Overhead Volume Variance

To further examine, fixed overhead volume variance can be sub-

divided in three categories
1. Efficiency variance : SC ( AQ-SQ)
2. Capacity Variance : SC (SQ-BQ) OR SC (SQ- RBQ)
3.Calendar Variance : SC (RBQ-
BQ) Where,
• SC= standard cost per unit of
fixed OH
• AQ= actual output in actual
hours worked
• BQ= budgeted standard output
planned in budgeted standard
hours
32
0
 Numerical

The following information in respect of a production process is

available for the month of January 2022

Budgeted Actual
Output (units) 30,000 32,500
Hours 30,000 33,000
Fixed overheads 45,000 50,000
Variable overheads 60,000 68,000
Working days 25 26

Compute relevant overhead

variances

32
1
 Solution
Measurement of per hour overheads
Standard hours per unit = Budgeted hours/Budgeted units =
30000/30000 = 1 hr Std hrs for actual output = 32500 units x 1 hr =
32,500 hours
Std FOH rate/ hr = Budgeted OH/ Budgeted hrs = 45000/30000 = Rs.
1,50 per hr Std VOH rate per hr = 60000/30000 = Rs. 2 per hour
Std FOH rate per day = 45000/25 days = Rs. 1800 per day
Recovered overheads = Std hours for actual output x Standard rate
For fixed overheads = 32500 h * Rs. 1.50 = Rs. 48750
For variable overheads = 32500 h * Rs. 2 = Rs.
65000 Standard overheads = Actual hours x
Standard rate
For fixed overheads = 33,000 x 2 = Rs. 66000
Revised budgeted hours = Budgeted hours/
Budgeted days x Actual days
= 30000/25 x 26 = 31,200 32
hours 2
 Fixed Overhead Variances

1. FO cost variance = Recovered overheads – Actual overheads

= 48750 – 50000 = Rs. 1250 (A)
2. FO expenditure variance = Budgeted overheads – Actual overheads
= 45000 – 50000 = Rs. 5000 (A)
3. FO volume variance = Recovered overheads – Budgeted overheads
= 48750 – 45000 = Rs. 3750 (F)
4. FO efficiency variance = Recovered overheads – Standard overheads
= 48750 – 49500 = Rs.750 (A)
5. FO capacity variance = Standard overheads – Revised budgeted
overheads
= 49500 – 46800 = Rs. 2700 (F)
6. Calendar variance = (Actual days – Budgeted days) x Standard rate
per day
= (26 – 25) x 1800 = Rs1800 (F) 32
3
 Variable Overhead Variance

1. Variable OH cost variance = Recovered OH – Actual OH

= 65000 – 68000 = Rs. 3000 (A)
2. VO expenditure variance = Standard overheads – Actual
overheads
= 66000 – 68000 = Rs. 2000 (A)
3. VO efficiency variance = Recovered overheads – Standard
overheads
= 65000 – 66000 = Rs. 1000 (A)

32
4
 Sales Variances

Sales
value
variance

Sales Sales
price volume
variance variance

Sales Sales sub –

mix volume
variance variance

32
5
 Sales Value Variance

 Sales value variance is the difference between the planned value

of sales and actual value of sales in a given time period.
 A firm should make all efforts to measure this gap and further
analyze the rea sons for the variations. We can calculate the
sales value variance through the following equation

 Sales value variance = Actual value of sales – Standard value of

sales

32
6
 Sales Value Variance

Sales value variance can be favorable or unfavorable, and this may

arise on account of following reasons:
1. Standard Selling Price vs Actual Selling price: There may be a
difference in standard selling price and actual selling price which
may be higher or lower than the pre-determined standard price.
This will cause variation in sales total sales value.
2. Actual Quantity sold vs Budgeted Quantity: Further, the actual
quantity of goods sold may also vary than the planned one which
could be higher or lesser. This will also cause variance in sales value.
3. Standard Sales Mix vs Actual Sales Mix: There may be a difference
in actual sales mix and the standard sales mix. The sales mix
can be explained in terms of combination of different
products/varieties produced by a firm

32
7
 Sales Price Variance

Sales price variance is the difference in Actual sales price and

Budgeted sales price.
This will cause difference in actual sales value as compared to
planned sales value. We can calculate the sales price variance
through the following equation:
Sales price variance = Actual quantity sold x (Actual price -Standard price)
It will be favorable if actual selling price is higher than the standard
selling price and vice versa.
The actual selling price depends on market conditions and other
external factors. Therefore, this variance is common

32
8
 Sales Volume Variance

Sales volume variance is the difference in Actual quantity of

sales and Budgeted quantity of sales.
This will cause difference in actual sales value as compared to
planned sales value. We can calculate the sales volume variance
through the following equation:
Quantity of sales will directly impact the sales value and hence
higher quantity sold than budgeted will create a positive variance and
vice versa
It can be calculated with the help of the following equation:
Sales Volume variance = Standard Price (Actual quantity of sales - Standard
quantity of sales)

32
9
 Sales Mix Variance

Sales mix variance can be explained in terms of difference in actual

quantity of sales mix and budgeted quantity of sales mix.
This will cause difference in actual sales volume as compared to
planned sales volume as all the varieties or products have different
selling price.
The sales mix is the combination of various products produced by a
firm and sold during a given period of time.
We can calculate the sales mix variance through the following equation:
Sales mix variance= Standard value of actual mix - Standard value of revised
standard mix

33
0
 Sales Sub – Volume Variance

 The difference between the budgeted sales and revised standard

sales is Sales Sub-volume variance.
 The sub-variance is calculated to the effect of RSQ
understand compared to budgeted sales as
quantity.
 This is also known as Sales Quantity Variance
 It can be calculated using the following
Sales quantity variance = (Revised standard sales quantity x Standard selling
equation:
price) - (Standard sales quantity x Standard selling price)

33
1
 Variance based on Profits

Variances Based on Profits

Total Sales Margin Variance:
• We can also calculate variances based on budgeted profit and actual
profit.
• This is a composite variance that is arrived based on other sub-
variances.
• It simply represents the difference between the standard margin of
profit in relation to budgeted quantity of sales during a particular
time period and the margin between the standard cost and the actual
selling price.
•We can calculate the sales margin variance through the following

equation: Total sales margin variance = Standard or budgeted margin –

Actual margin
33
□ Remember: The total sales margin 2
variance may occur on
 Variance Based on Profits

Margin Variance Due to Selling Price:

• Sales margin variance may occur on account of the difference
between the standard price of the quantity of sales offered during
the period and the actual price.
• This can be calculated as follows:

Sales Price Variance = Actual Qty of sales ( Standard Price – Actual

Price)
•We can also calculate sales margin variance on account of
difference in selling price as follows:
Sales Price Variance = (Budgeted profit on actual sales at Standard Price and
Standard cost – Actual Price)

33
3
 Variance Based on Profits

Sales Margin Variance Due to Volume of Sales:

•The ‘volume’ represents the quantity. The sales margin variance on
account of quantity of sales may occur due to the difference
between the budgeted quantity of sales and the actual quantity of
sales.
•For further analysis, we can calculate two more sub-variances on
account of change in the ratio of quantities of sales of different
products known as ‘mix variance’.
•This may "Occur on account of actual mix of quantities that may be
more or lesser than the budgeted sales mix of different quantities.
Sales Volume Variance = (Budgeted Profit on standard qty of Sales –
Standard profit on actual qty of Sales)
Sales Volume Variance = Budgeted Profit – Profit on actual qty of Sales at
Standard price and standard costs
 Variance Based on Profits

Sales Margin Variance Due to Sales Mixture

Sales Quantity Variance:
Standard Contribution per unit * (Standard proportion for Actual Sales
– Actual proportion)
Sales Margin Variance Due to Quantity of Sale or Sales Quantity Variance:
Sales Quantity Variance:
Standard Average Contribution margin per unit * (Total Budgeted
Sales – Total Actual sales)

33
5
 Key Words
 Standard Cost: A pre-determined cost for various cost components
to set standards to be followed
 Actual Cost: Costs actually incurred on different cost components
 Variance: The difference between the standard cost and the actual
cost
 Material Cost Variance: The difference between standard cost of
raw materials and actual cost of raw materials
 Labour Cost Variance: The difference between standard labour cost
and actual labour cost
 Overhead Cost Variance: The difference between standard and
budgeted overheads of a production process and actual overheads
 Sales Variance: The difference between budgeted value of sale and
actual value of sale
 Profit Margin: The difference between budgeted profit per unit
and the actual profit per unit.
 Yield Variance: The difference between standard output expected
from actual inputs and actual output obtained 33
6
 Cost and Management Accounting
Session 9

Chapter No 9 Management Accounting in Global

Perspective
 Introduction

Organisations across the globe have a common goals in terms of

profitability, quality of products and customer service. The focus is on
cost optimization.
The market features have changed in terms of global competition,
advanced technology and faster pace of communication.
It is a global market with much faster accessibility through internet, a
24*7 market where one can have trade and transactions round the
clock.
The transactions, transfer of goods, settlement etc have no
boundary lines. The development and effective functioning of
international organisations have changed the way of international
Business, such as :
• WTO: World Trade Organisation
• EU: European Union
• ASEAN: Association of South East Asian Nations
• SAARC: South Asian Association for Regional Cooperation
3
• BRICS: Brazil, Russia, India, China and South Africa
3
 Introduction Contd…
The management accounting problems are no longer simple, but they have
become more complex. The differences have emerged in terms of the
following factors:
1. Enhanced Competition: The new and much developed information
and communication technology enabled customers to find and get
access to what they wanted wherever it was available. This has
resulted in greater supplier competition. The global market is no
longer across the globe, but a small market on customers table.
2. Advanced Technology: The advanced production techniques and much
faster production operation system allowed suppliers to profitably sell
their goods of distinct not only at low but also at competitive prices. The
new techniques and continued product innovations have mainly
focused on satisfying customer demands. Both the above
developments have successfully created competitive environment at a
faster pace. The traditional management accounting systems are no
longer relevant and they cannot cope up with the new challenges as the
spirit of competitiveness has been defined as defeating your
competitors not only on costs but also on the quality3
3
 3.Positive Contribution: This kind of philosophy greatly emphasizes
that the firm needs to control unit costs and achieve profitability by
producing all it can sell at a price that exceeds variable costs, or in
other words the positive contribution.
4.It is all about the Customer: The new business environment calls
for two major steps to come over the competitiveness, which
traditional management accounting system did not even feel. The
present mantra for a business success depends on two crucial
factors: a. Listen to the customer needs and preferences and b.
Increased focus on eliminating the waste.
5.It is a new world !: The whole management accounting
strategies have undergone sea changes. The new concepts of
inventory management, classification of cost, new cost allocation
strategies, workers participation for continuous product improvements,
etc., have brought significant changes in the planning, practices
and strategies of modern managerial accounting practitioners
3
4
 Activity as a Focus

The focus of globally competitive firms is to identify non-value-

added activities and eliminate to avoid wastage and, on the other
hand, focus on the continuous flow of value-adding activities to a
greater extent.
To further strengthen the activity audit, the following approaches have
been found useful in an efficient activity management practices:
1. Activity Management
2. Activity Cost Accounting
3. Activity-based product costing

3
4
 Activity as a Focus

 Activity management: An efficient activity management system a

process to identify all the activities, measure its relevance and utility
to the product, extent of particular activity in value addition to the
product, etc. In fact, it is the exercise to eliminate the non-financial
outcomes of activities. The major focus of this approach is
practically to ignore the costs and pay more attention to eliminate
the waste since waste causes the increased costs.
 Activity cost accounting: Another concept is activity cost accounting
which measures the costs of activities and focuses on eliminating
waste. In practice, it is observed that many activities are
inherently wasteful. This aspect requires prompt attention of the
management to identify different cost drivers.
 Activity-based product costing: The activity-based product costing
mainly stresses on activities to put them at logical place and assign
them appropriate costs. Identifying appropriate cost driver is also an
important exercise in this area as it relates to product cost
3
4
 Change in Focus

Following are the areas which need focus as per the modern
management practitioners:
1. Eliminate Waste: The modern managerial accounting system needs
to be developed which pays more attention to eliminate most of the
material on financial control systems, especially the use of
variances from standard cost budgets to measure the
performance of operating managers. The budgets are needed for
planning, but should not be strictly used for cost control.
2. Move away from traditional view of costs: The modern
managerial practitioners are also of the view that there is a
need to eliminate breakeven analysis and cost behaviour. There is
not much significance for separating the costs on traditional basis,
such as fixed and variable costs.
3. Constrained Optimization: The objective function is either a cost
function or energy function, which is to be minimized, or a
reward function or utility function, which is to be maximized.
Constraints can be either hard constraints, which set conditions for
the variables that are required to be satisfied, or soft constraints,
which have some variable values that are penalized in the
objective function if, and based on the extent that,
3 the conditions
on the variables are not satisfied 4
 Management Accounting in a Competitive World

1. Financial and Non financial data: The management accounting deals

with both financial and non-financial data to support a wide
range of managerial decisions, whereas financial accounting
focuses only on financial data to support investors’ and
creditors’ capital allocation decisions. However, it is observed that
real value-add is the integration of financial reporting with
operational information.
2. Forward looking: Management accounting looks forward as well
as backward, whereas financial accounting is oriented solely
toward history. Management accounting involves future forecasting
and anticipations as what will, could or should happen, as
well as indicating the past happenings and results

10
 Management Accounting in a Competitive World

3.Tools and Techniques: Management accounting uses forecasting.

Planning and budgeting for managerial decision making. Financial
accounting focuses on financial statements, financial ratios and
financial reporting. Important instruments are balance sheets and
annual reports.
4.Inward vs Outward looking: In practice, management
accounting looks outward as well as inward, whereas financial
accounting is solely focused on what happens internally within an
enterprise.
5.Identifying threats and opportunities: Management accounting
involves proactively seeking and identifying opportunities and
threats that an enterprise faces from customers, competitors,
suppliers, regulatory agencies and other external parties. However,
financial accounting has hardly any role in this.

1
1
 Management Accounting in a Competitive World

6.Enhancing Business performance: Management accounting is

focused on enhancing business performance in a competitive
environment, not simply on ensuring compliance with standards and
regulations.
7.Value Creation: Management accountants contribute directly
to the creation of value, not merely to protect and preserve it.
The role of management accountants has increased considerably
in the present global competitive environment as their managerial
decisions have direct impact on cost optimization and revenue
increase, thereby contributing more to the profit growth of a firm.

12
 Management Accounting and Global Environment

1. The major responsibility is to design internal accounting

systems to achieve the goals of the firm and at the same time have
perfect monitoring of the operations.
2. There is a need to redefine the parameters of performance
evaluation which are basically based on budgets and variance
analysis.
3. Understand the implications of conducting business across the
globe. In this case, interactions with individuals, firms and
others assume significance. Therefore, a managerial professional
have to acquire a global vision to analyze and understand business
intricacies across the globe.
4. Management accountants need to thoroughly understand the
applications of new costing techniques to effectively use them. An
in-depth analysis is required to assess the impact of these strategies
on costing and pricing of a product in comparison to global prices.
13
 5.They also need to understand the various ethical issues of
business which affect the very brand of the product and firm both.
The overall impact of business ethics should be evaluated and a
communication passed across the work force to make them more
cautious toward this important issue.
6.Of course, the prime responsibility is to establish a perfect
management costing system where more focus is required on activity
management in the changing context.
7.Identification of proper cost drivers has been quite useful in
eliminating the non-value activities and thereby reducing the costs.
This exercise has been found quite useful and advantageous. This
should be made for systematic approach.
8.Management accounting professionals have a key role in
optimizing the performance of the firm. They have a close track not
only on costing and revenue aspects but also on other important
factors related to the decision- making process

14
 Global Management Accounting Principles

1. Effective Communication systems: An effective communication

system which provides insight that is influential helps in strategy
development and execution. It also helps in better conversation
among the groups.
2. MIS: Availability of information which is relevant, reliable and
easily accessible.
3. Impact of Communication and Information: The further requirement
is to analyse impact of communication and information on value
of the firm. This analysis also provides insight into various
alternatives and options to prioritize actions by their impact on
different outcomes.
4. Then the next important pillar of the management accounting
principle is stewardship, which builds trust and suggests
accountability and credibility for long-term sustainability.
5. Integrity and ethics are also more important for an effective
management accounting system. This, of course, is developed
among the skilled and competent people who are closely
15
associated in implementing the management accounting
 Changing Global Management Practices – A
Perspective
1. Cost Transformations and Management: The exercise of reducing
waste but at the same time preserving or enhancing value. It
involves the continuous exercise to identify activities and
eliminate waste. The resources saved through this exercise can be
invested in customer focused innovations.
2. External Reporting: The management accounting professionals are
also required to integrate a comprehensive assessment of
financial and non- financial performance, business model per
se, risks associated and strategies for effective assessment of
future performance.
3. Financial Strategy: This requires identification of the future
strategies which will be helpful for maximizing the firm’s net present
value. This also involves appropriate allocation of available capital
resources among the competing opportunities and an effective
implementation and monitoring system to evaluate the selected
strategies to achieve pre-decided goals and objectives of the firm
16
 Changing Global Management Practices – A
Perspective

4.Internal Control: The strengthening of internal control systems

and procedures is also a prime responsibility of management
accounting professionals. They need to prepare a framework of
policies, systems, processes and procedures for effective management
of risks. There has to be a well defined system to ensure efficient and
effective implementation of the framework.
5.Investment Appraisal: A decision to evaluate an investment
proposal keeping in view the financial viability and technical
feasibility is an important decision area where management
accounting professional can play a crucial role. They can prioritize the
investment option based on affordability and expected returns and
different kinds of risk associated with the investments

17
 Changing Global Management Practices – A
Perspective

6.Management and budgetary control: This is of course, a traditional

role of managerial accounting professionals to control performance
again budgeted targets. The controlling areas may include
projects, people, activities, processes, sales volumes and revenues,
resource quantities, operating costs and expenses, asset, liabilities and
cash flows, etc.
7.Price, discount and product decisions: The most crucial decision in a
firm's operations is to decide what to produce, how much to produce
and at what Selling price and discount the product is to be sold

18
 Management Accounting & Developed Accounting
Systems
1. E-Commerce
The rapid growth of E-commerce and E-business witnessed the
rapid electronic transformation of the business environment and the
way business is done. e-commerce may be defined as buying and
selling of products or services online or over the internet and e-
business is a much broader concept.
Managerial professionals have also quickly embraced e-
accounting by harnessing the power of online communications to
streamline the procedures of management accounting
For Eg: e-budgeting is adopted by several companies to quickly and
effectively transmit the information needed to construct a budget from
far flung business units around the globe.
E-business is here to stay and as per a market report, this is
just the beginning of significant growth of the e-commerce sector in
India
19
 Management Accounting & Developed Accounting
Systems

1. E-Commerce contd…Some facts about e-tailing:

• Despite strong growth of E-commerce in India , E-tailing is only 4 to
5% of total Retail sales
• In the festive sale (September 29-October 4, 2019), the e-tailers in
India achieved US$ 3 billion of Gross Merchandise Value (GMV).
• Online Travel accounts for ~ 70% of E-commerce business in India.
This business has grown at a compounded annual growth rate
(CAGR) of 32% over 2009-2013
• E-retail market is expected to continue its strong growth, by
registering a CAGR of over 35 per cent and to reach Rs 1.8 trillion
(US$ 25.75 billion) by FY20

20
 Management Accounting & Developed Accounting
Systems

1. E-Commerce contd…Some facts about e-tailing:

For every Rs 100 spent on E-tailing , Rs 35 is spent on supporting
services like warehousing, payment gateways and logistics among
others
Demand in India exists in almost 4000 to 5000 cities and towns but
physical retail is not present in almost 95% of them because of
prohibitive real estate costs

21
 Management Accounting & Developed Accounting
Systems
2. Increased Role of service sector:
The market share of service sector has been growing across the globe.
Several governments have made engagements and provided
incentives to boost this sector. The telecommunications, financial
services and airline industries are among them.
As more and more firms provide financial, medical,
communication, transportation, consulting and hospitality services,
managerial accounting techniques must be adapted to meet the
needs of managers in those industries.
As we are aware that the main difference between service and
manufacturing firms is that most Services are consumed as they are
produced, the services cannot be inventoried as manufactured goods. It
has been observed that many of the techniques developed for
measuring costs and performance in manufacturing firms have
been adapted successfully to service industry firms.
22
 Management Accounting & Developed Accounting
Systems

3. Increased Global Competition:

The extensive global competition is forcing firms to strive for
excellence in product quality and service which was not the case earlier.
MNC’s face several challenges that do not confront domestic
companies. Political systems, accounting rules for external reporting,
legal systems and cultural norms vary widely across countries.
Therefore, Management professionals must be aware of various
policies and practices to successfully carry out operations across
countries

23
 Management Accounting & Developed Accounting
Systems

4. Stress on Cross Functional Groups:

In past, managers used to stick to their own work area: -
Production managers focused on how best to manufacture a product or
produce a service - Design engineers often emphasized
engineering elegance rather than designing product for
manufacturability - Managerial accountants provided information for
decision making, planning, control and performance evaluation.

Today, the things have changed drastically.

The cross-functional approach has this narrow manageria
replaced perspective l

24
 Management Accounting & Developed Accounting
Systems

4. Stress on Cross Functional Groups contd….

The functional groups bring together operations managers,
marketing managers, purchasing and material handling experts,
design engineers, quality management personnel and managerial
accountants to focus their varied expertise and experience on virtually
all management issues.
The managerial accounting professionals develop information
system and provide data ranging across all aspects of the
organizations internal operations and external environment.
They also work as an integral of the cross-
member
interpreting information and analyzing functional team, the
implications
alternatives. The cross-functional groups create value for the of
firm
by
understanding customer's needs in the mostdecision
effective manner
possible.

25
 Management Accounting & Developed Accounting
Systems

5. Product Life cycles and Diversity:

In view of changes in technology at faster pace, the lifespan of most
products is becoming shorter.
In the computer industry, for example, product models are used only
a few years before they are replaced by more powerful versions.
To be competitive, manufacturers must keep up with the rapidly
changing market place.
The challenge before management accounting professionals is to have
timely information about production costs and other product
features in order to meet effectively to the competition.

26
 Management Accounting & Developed Accounting
Systems

6. Focus on Inventory Management

In traditional Manufacturing system , inventories of raw materials and
parts, WIP and finished goods were kept as a buffer against the
possibility of running out of an item that may be required.
Large buffer inventories consume valuable resources and cost
heavily to a firm Hence, many manufacturers have changed their
approach to production and inventory management. These
manufacturers have adopted a strategy for controlling the flow of
manufacturing in a multistage production process.
In a Just-in-time (JIT) production system, raw materials and parts
are purchased or produced just in time to be used at each stage of the
production process.

27
 Management Accounting & Developed Accounting
Systems

7. Total Quality Management Concept (TQM):

The concept of TQM has emerged very strongly in the recent past.
If a component has to be produced “Just in Time” for the next
production stage, it must be “ just right” for its intended purpose.
A light delay in the inventory process may shut down the entire
production line, entailing considerable cost.
Therefore Management accountants have become increasingly
involved in monitoring product quality and measuring the costs of
maintaining quality. This information helps companies maintain
programs of TQM

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 Modern Cost Management System

1. Assessment of cost of the resources consumed in performing

significant activities.
2. Continued focus to identify and eliminate non-value- added
costs. The costs incurred on activities which do not increase the
value of a product can be eliminated with no deterioration of
product quality, performance or perceived value.
3. More stress on measuring efficiency and effectiveness of all
major activities performed in the firm.
4. On going efforts to identify and evaluate new activities that can
improve the future performance of the firm

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 Key Words
1. Global Business: Business transactions conducted across the world

2. WTO: World trade organisation

3.GlobalCompetitive Firm: A firm having competitive advantagein

global business
4.Activity Management: The focus of a firm to manage relevant and value
added activities rather than cost
5. Activity Cost accounting: Measurement of cost based on cost drivers

6. Management Ethics: Managerial practices with value and ethics

7. Cost optimization: Optimum utilization of resources at a minimum cost

8. External Reporting: Financial reports meant for external stakeholders

9. Investment Appraisal: Assessment of viability of anew investment

opportunity
10. E-Business: Business transactions through internet
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 Let’s Sum Up

Today is the last session for Costing !

Hope you are clear about all the concepts of :
• Various types of Costs and their classification
• Material, Labour and Overhead costs and their efficient management
• Job and Batch Costing
• Contract costing
• Process Costing
• Marginal Costing and Break even analysis
• Absorption Costing
• Standard Costing and understanding Variances
• Management Costing is increasingly important in an ever
increasing competitive world !
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